A Ltd. (lessee) is in the business of supplying bottled water to various restaurants in Delhi. For the bottle filling process, it takes a machine on lease from Company B for 10 years. A Ltd. has the right to control with respect to when to use, how to use, and how much to use. As per the agreement terms, A Ltd is required to pay Rs. 2 per bottle filled by using the leased machinery or a minimum payment of Rs. 1,00,000 each year, whichever is higher to B Ltd.
What payments are to be considered for the purpose of calculating lease liability?
PARA 4 OF IND AS 17-LEASES
The following terms are used in this standard with the meanings specified:
A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.
An operating lease is a lease other than a finance lease.
A non-cancellable lease is a lease that is cancellable only:
(a) upon the occurrence of some remote contingency;
(b) with the permission of the lessor;
(c) if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or
(d) upon payment by the lessee of such an additional amount that, at inception of the lease, continuation of the lease is reasonably certain.
REPLY: As per Para 27 of Ind AS 116, "at the commencement date, the lease payments included in the measurement of the lease liability comprise the following payments for the right to use the underlying asset during the lease term that are not paid at the commencement date:
(a) fixed payments (including in-substance fixed payments as described in Para B42), less any lease incentives receivable;
(b) variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date (as described in paragraph 28);
(c) amounts expected to be payable by the lessee under residual value guarantees;
(d) the exercise price of a purchase option if the lessee is reasonably certain to exercise that option (assessed considering the factors described in paragraphs and
(e) payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.".
Para B42 of Ind AS 116 states that "lease payments include any in-substance fixed lease payments. In-substance fixed lease payments are payments that may, in form, contain variability but that, in substance, are unavoidable.".
In the given case, A Ltd is required to make a minimum payment of Rs. 1,00,000 each year to B Ltd, which is unavoidable. In view of Para B42, the annual payment of Rs. 1,00,000 is an in-substance fixed lease payment and will be considered in measuring the right-of-use asset and lease liability at the commencement date.
PARA B42 OF IND AS 116: A LESSEE SHALL REMEASURE THE LEASE LIABILITY BY DISCOUNTING THE REVISED LEASE PAYMENTS IF EITHER
(a) There is a change in the amounts expected to be payable under a residual value guarantee. A lessee shall determine the revised lease payments to reflect the change in amounts expected to be payable under the residual value guarantee.
(b) There is a change in future lease payments resulting from a change in an index or a rate used to determine those payments, including, for example, a change to reflect changes in market rental rates following a market rent review.
The lessee shall remeasure the lease liability to reflect those revised lease payments only when there is a change in the cash flows (i.e., when the adjustment to the lease payments takes effect).
A lessee shall determine the revised lease payments for the remainder of the lease term based on the revised contractual payments.
Para 28 of Ind AS 116 states, "Variable lease payments that depend on an index or a rate described in Para 27(b) include, for example, payments linked to a consumer price index, payments linked to a benchmark interest rate (such as LIBOR), or payments that vary to reflect changes in market rental rates.".
PARA 28 IND AS 116: Variable lease payments that depend on an index or a rate described in paragraph 27(b) include, for example, payments linked to a consumer price index, payments linked to a benchmark interest rate (such as LIBOR), or payments that vary to reflect changes in market rental rates.
In the given case, payment of Rs 2 per bottle packed is variable by nature because the number . of bottles packed will vary. However, these variable payments are not dependent on an index or rate. Hence, they are excluded from the calculation of right-of-use assets and lease liabilities as of the commencement date.
PLEASE NOTE:
1. An annual payment of Rs. 1,00,000 will be considered in measuring lease liability, and any payment over and above Rs. 1,00,000 will not be considered in measuring lease liability.
2. Any payment over and above Rs. 1,00,000 will be recognized in profit or loss as and when they are incurred. The variable rentals will be charged to the profit and loss account as and when incurred.
DISCLAIMER: The case study presented here is only for sharing information with readers. In case of necessity, do consult with professionals.
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