A Guide to Lease Accounting

The Indian Accounting Standards (IND AS) have witnessed significant changes over the years, aiming to align Indian accounting practices with international standards. One of the key accounting standards, IND AS 116, brings a substantial shift in the accounting treatment of leases. This article explores IND AS 116, its impact on financial reporting, and how it aligns India with the International Financial Reporting Standards (IFRS) 16.

?What is IND AS 116?

IND AS 116, also known as "Leases," replaces the previous standard and introduces a new approach to lease accounting. It was introduced to provide a more faithful representation of leasing transactions, thus enhancing transparency and comparability.

Key Changes and Features of IND AS 116:

1.???? Lessee Accounting: One of the most significant changes under IND AS 116 is the treatment of leases by lessees. Previously, lessees classified leases as either operating or finance leases, affecting the income statement and balance sheet differently. Under IND AS 116, most leases are recognized on the balance sheet as a right-of-use asset and a lease liability.

2.???? Right-of-Use Asset: Lessees recognize the right-of-use asset at the present value of lease payments. This asset represents the lessee's right to use the underlying asset during the lease term.

3.???? Lease Liability: Lessees recognize a lease liability on the balance sheet, reflecting their obligation to make lease payments over the lease term.

4.???? Amortization: The right-of-use asset and lease liability are amortized over the lease term, impacting the income statement. This results in front-loading of expenses over the early years of the lease.

5.???? Lease Term and Discount Rate: Determining the lease term and the discount rate is crucial, as they have a direct impact on the calculation of the right-of-use asset and lease liability. The lease term includes the non-cancellable period and options to extend or terminate the lease.

6.???? Lessor Accounting: Lessor accounting remains largely unchanged from the old standard, with the classification of leases into finance and operating leases continuing. Lessor accounting depends on the risks and rewards associated with the lease.

?Impact of IND AS 116:

1.???? Balance Sheet Impact: The most noticeable effect of IND AS 116 is the significant increase in lease-related assets and liabilities on the balance sheet. This provides a clearer picture of a company's financial commitments and obligations.

2.???? Income Statement Impact: Lessees may experience changes in their income statements due to the front-loading of lease expenses. This could affect financial metrics and ratios, such as EBITDA and interest coverage.

3.???? Disclosure Requirements: IND AS 116 imposes detailed disclosure requirements to enhance transparency, including information on lease commitments, maturity analyses, and key assumptions.

4.???? Operational Impact: Entities may need to revisit their lease agreements and consider whether leasing is still an attractive option compared to ownership (Lease vs Buy decision). Furthermore, lease negotiations may be influenced by the new accounting standards.

?Implementation:

Implementing IND AS 116 can be complex and may require changes in accounting systems, processes, and internal controls. Companies should consider the following steps:

1.???? Review existing leases and determine their impact on the balance sheet and income statement.

2.???? Identify and assess the leases accurately.

3.???? Calculate the present value of lease payments and determine the Incremental Borrowing Rate

4.???? Implement necessary changes in the accounting policies and make necessary adjustments.

5.???? Communicate changes to stakeholders and educate internal teams.

?IND AS 116 represents a significant change in lease accounting, aligning Indian accounting standards with international practices. The standard aims to provide a more realistic representation of leasing transactions, enhance transparency, and improve comparability. Companies need to carefully assess the impact of IND AS 116 on their financial statements and prepare for its implementation to ensure compliance and smooth transition.

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