Ind AS 116 Explained: A Foundational Guide on Lease for Indian Businesses

By Master Brains – Your Trusted Ind AS Consultants

Your search ends here! This is the “only” article you ever need to refer to if you want to get deep understanding of the Ind AS 116.

Hence, without any delay, let’s start this article which covers the complete guide on Indian accounting standard 116, its application and compliance along with practical insights from Master Brains.

This is Part 1 of our in-depth Ind AS 116 Guide.

1. What Exactly is Ind AS 116? – The Intro

“If you control it, you should show it?”

Meet our beloved Ind-AS 116 that changed how companies consider leases in India since its implementation on 1 April 2019 aligned with IFRS 16, replacing the old AS 19 (Transition from Indian GAAP to Ind AS 101).

The core idea behind Indian accounting standard 116 by the ICAI is simple in principle, if you are using some thing under a lease and controlling it, it should reflect on your financial statements.

Main Objectives are:

• Create transparency around leasing
• Minimizing the differences between operating and finance leases
• Bring India in sync with IFRS 16

This is the future of Indian accounting standard.

2. What Falls Under Indian Accounting Standard 116? – The Scope

Ind AS 116 applicability covers most lease arrangements we can think of (property, vehicle), with a few exceptions:

• Natural Resource Lease (like oil)
• Intellectual Property Licensing Agreements (Ind AS 115)
• Service concession arrangements (Ind AS 115)
• Biological assets Lease (Ind AS 41)
• Intangible Assets License under Ind AS 38

There are 2 Ind-AS 116 exemptions for:

1. Short term leases: less than or equal to 12 months
2. Low value leases: These are not dependent on other assets and can take benefit from low value asset like laptops, phones, small printers, etc.

3. Lease Contract – The Definition

Any contract that gives the right to control an identified asset for a period in exchange for payment can be called lease contract.

Two important factors must exist:

1. Identified asset: Specified and not substitutable by the lessor.
2. Control: The lessee should receive most of economic benefits and have key decision-making rights over use.

What we understand with this that we need to look beyond the traditional leases. Further, “Lessee” is the party who obtains these right and “Lessor” is the party who gives away this right.

4. Let’s Find the Lease – The Identification

The mantra is to look past the name of the lease contract and focus on the substance of the lease agreement.

As per Ind-AS 116, all 3 conditions should be the part of contract:

1. An Identified Asset: The specified assets are distinct and defined in the contract explicitly or implicitly. Most importantly, the supplier shouldn’t be able to replace the asset at will during the lease period.
2. Right to Obtain Economic Benefits: from using the asset.
3. Right to Direct the Use of the Asset: The lessee should control over both the manner and purpose of using the asset. If these are fixed, lessee must either operate or have designed it so the supplier can’t change.

5. Important terms in Ind-AS 116 – The Considerations

Knowing these will help you in Ind AS Implementation.

5.1 Separate Lease Component

Some contracts cover more than one asset or service that we need to separate for accounting purposes.

To find a separate component:

1. Can the lessee use the asset on its own or with things they already have or can easily get?

   (+)

2. Can the asset function on its own, apart from other assets in the contract?

If the answer is “positive”, then you have it.

5.2 Non-Lease Component

It is quite normal for one contract to cover both lease and non-lease parts.

Like if you have rented an office space, this gives you the right to use the office space (lease component) and aseparate service for security and maintenance (non-lease component).

Because this standard only applies to the lease portion. The non-lease services fall under Ind AS 115, which deals with revenue from contracts. To treat everything correctly, you need to separate and allocate the total payment based on ratio of stand-alone prices of each component.

5.3 Combination of Contracts

There are times when we may enter into multiple contracts with the same vendor around the same time. Even if they look separate on paper, they might need to be combined for accounting.

Combine contracts when:

1. They were negotiated as a package deal, meaning agreed together with one purpose.
2. The payment in one contract depends on the terms of another contract.
3. The leased assets are linked.

5.4 Lease Term

The lease term determines how long the lessee will recognize the right-of-use (ROU) asset and lease liability. (meaning of these terms in Part 2).

Item	Segments	Time
I	Non-Cancellable Period	Period which the lease is binding on both parties.
II	Extendable Period if any in the contract	Period covered by an option to extend the lease.
III	Termination Period if lessee is likely to not terminate the contract	Period covered by an option to terminate the lease.
(SUM = I+II+III)	LEASE TERM	xxxx

6. Lease Inception Date vs Commencement Date – The Start

When we work with leases under Indian Accounting Standard 116, there are two important dates that often get us confused, the Inception Date and Commencement Date. They play very different roles in lease accounting.

I. The inception date is the earlier of the date the lease contract is signed or committed by both parties. At this date, the lease is identified, classified and important consideration as discussed above is fixed. It is the agreement date but nothing is recorded in your books.

II. The commencement date is the date when the lessee obtains the right to use the leased asset and made available for use by the lessee. It is the date when accounting starts in the books.

7. What Counts as Lease Payment? – The Not Just Rent

Under Ind AS 116, lease payments are more than just the fixed monthly rent you might see in a contract. Formula:

Lease Payments = Fixed Payments – Lease Incentive

+ Variable Payments (based on index/rate at commencement date)

+ Purchase Option Price (if reasonably certain)

+ Termination Penalties + Residual Guarantees

This doesn’t include payments based on usage or services like maintenance.

Let’s understand with an illustration:

A company, Blogic Pvt Ltd, leases equipment for 3 years. The contract includes:

1. ₹ 42,000 fixed monthly rent
2. 5% Annual rent increase based on CPI
3. ₹ 1,20,000 lakh buy option at the end, which the company plans to use
4. ₹ 20,000 annual maintenance
5. ₹ 50,000 Residual value guarantee & ₹ 35,000 expected market value
6. ₹ 500 per unit usage charge, based on production

Now calculate:

1. Fixed Payments:

Year 1: ₹ 42,000*12 months = ₹ 5,04,000

Year 2: ₹ 5,04,000*105% = ₹ 5,29,200

Year 3: ₹ 5,29,200*105% = ₹ 5,55,660

Total Fixed Payment = ₹ 5,04,000 + ₹ 5,29,200 + ₹ 5,55,660 = ₹ 15,88,860

• Purchase Option (certain): ₹ 1,20,000
• Residual Guarantee: ₹ 50,000

Total Lease Payments = ₹ 15,88,860 + ₹ 1,20,000 + ₹ 50,000 = ₹ 17,58,860

Stay Tuned for Part 2…

Ind AS 116 Accounting: Step-by-Step Guide to Journal Entries & Disclosures

In the next blog, we will take a deep dive into lease accounting in India and some special tips by Ind-AS experts.

Our Final Word

We get it, Ind AS 116 can seem pretty tough and confusing to apply. But we are here for you. For every startup or large organization, Master Brains can provide the clarity and guidance needed for successful Ind AS 116 implementation and compliance. With decades of experience in the industry, our Ind-AS consultancy services is one of a kind and we are committed in partnering with you at every step.