Practical approach to implement Ind AS 116

In this article we will discuss about the accounting treatment in books of lessee only.

Basics on applicability of Ind AS 116 "Leases"

• Ind AS 116 is proposed to be effective from annual periods beginning on or after 1st April, 2019.

• Ind AS 116 introduces a single lessee accounting model and requires a lessee to recognise right of use assets and lease liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value.

• The lease liability is initially measured at the present value of the lease payments to be made over the lease term. The right-of-use asset is initially measured at the amount of the lease liability, adjusted for lease prepayments, lease incentives received, the lessee's initial direct costs (e.g., commissions) and an estimate of restoration, removal and dismantling costs.

• Under Ind AS 116, a lessee subsequently measures & depreciates right-of-use (ROU) assets similarly to other non-financial assets (such as property, plant and equipment).

• The lease liability is measured in subsequent periods using the effective interest rate method.

The above are general and basics of Ind AS 116 'Leases'.

Now we will discuss practical approach to how to apply Ind AS 116 which is proposed to be effective from 1.4.2019.

As a practical expedient, an entity is not required to reassess whether a contract is, or contains, a lease at the date of initial application. Instead, the entity is permitted:

(a) to apply this Standard to contracts that were previously identified as leases applying Ind AS 17, Leases.

(b) not to apply this Standard to contracts that were not previously identified as containing a lease applying Ind AS 17.

So if any old contract or arrangement is not considered as lease arrangement as per Ind AS 17 then it need not be evaluated for lease accounting under this standard.

After identifications of any arrangement / contracts as lease then the next step is by what amount ROU assets and lease liabilities need to be recognized

Once contract is identified as a lease arrangement on transition, the standard gives various options to recognize ROU assets and Lease Liabilities as below assuming that Ind AS 116 is notified and applicable from 1.4.2019:

(1) Option 1 - Retrospective approach:

Under this option, the entity is requiredto determine the carrying amount of ROU and lease liabilities at the earliest comparative period as if those leases had been accounted for under Ind AS 116 since inception of the contract. Under this option:

• Difference between the ROU assets and liabilities are adjusted to retained earnings as on 1.4.2018

• Previous year PnL number is to be restated and give the impact for changes of Depreciation, Interest cost and lease liabilities in FY 2018-19

(2) Retrospective with cumulative effect (modified retrospective impact) :

a. Option 2- Retrospective but using the incremental borrowing rate on transit date

• Under this option, the Lease liabilities are recognized based on incremental borrowing rate on the initial application date (1.4.2019) and ROU assets are recognized based on option 1.
• The difference between Lease Liabilities and ROU Assets is adjusted to Retained earnings as on 1.4.2019
• No change in FY 2018-19 numbers

b. Option 3 - ROU assets equal to the lease liability:

• Under this option, the Lease liabilities are recognized based on incremental borrowing rate on the initial application date (1.4.2019) and same amount is recognized for ROU assets

• No any impact to Retained earnings or any previous year numbers

Note: lessee's incremental borrowing rate : The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.

Let's understand by way of Example:

Considering the above, following are the accounting treatments:

[1] Previously, this amount was charged to P&L as rent expense. In the restated P&L for 2018-19, the rent expense will not exist.

IND AS 116 is expected to have a significant impact on the financial statements of a lessee as below:

Statement of financial position

• Recognition of right of use asset and a corresponding lease liability results in an increase in the amount recognized for financial liabilities and assets for entities that had material operating leases.

• New accounting requirements for lessees will impact debt equity ratios and may also cause entities to breach existing debt covenants.

Statement of comprehensive income

• De-recognition of operating lease charges and recognition of depreciation and finance costs would positively impact EBIT and EBITDA.

• Recognition of depreciation on right to use assets and unwinding of finance cost on lease liabilities result in higher costs being recognized during the beginning of the lease term.

Statement of cash flow

Presentation of lease payments as 'cash flow from financing activities' has a favorable impact on 'cash flow from operations'.

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