Ind AS 116 - Leases: Comprehensive Guide for CA Final Students

Ind AS 116, 'Leases', fundamentally changed lease accounting, particularly for lessees, by introducing a single on-balance sheet model. This standard aims to provide a more faithful representation of a lessee's assets and liabilities, eliminating off-balance sheet financing for most leases. For CA Final students, mastering Ind AS 116 is crucial for Financial Reporting (Paper 1), requiring a deep understanding of its principles, measurement requirements, and practical application.

Quick Answer for Featured Snippets:
Ind AS 116 requires lessees to recognise a 'Right-of-Use' (ROU) asset and a 'Lease Liability' on the balance sheet for almost all leases, eliminating the distinction between operating and finance leases for lessees. Lessors continue to classify leases as operating or finance leases, similar to previous standards.

Introduction to Ind AS 116: The New Lease Accounting Paradigm

Ind AS 116, 'Leases', issued by the Ministry of Corporate Affairs (MCA) in India, is based on IFRS 16 'Leases'. It became effective for annual periods beginning on or after April 1, 2019. The primary objective of Ind AS 116 is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents lease transactions, particularly by bringing most leases onto the balance sheet for lessees.

Key Changes Introduced by Ind AS 116:

• Single Lessee Accounting Model: Eliminates the distinction between operating and finance leases for lessees. Almost all leases result in the recognition of a Right-of-Use (ROU) asset and a corresponding lease liability.
• Enhanced Transparency: Provides a more accurate picture of a company's assets and liabilities, improving comparability across entities.
• Impact on Financial Ratios: Significantly affects key financial metrics such as EBITDA, debt-to-equity ratio, and return on assets.

Scope of Ind AS 116:

• Applies to all leases, with certain recognition exemptions.
• Does not apply to leases of intangible assets (covered by Ind AS 38), leases of biological assets (covered by Ind AS 41), exploration rights for minerals, oil, natural gas, and similar non-regenerative resources (covered by Ind AS 106), and service concession arrangements (covered by Ind AS 115).

Why it Matters (from Ind AS 17/AS 19 to Ind AS 116):
The previous standard (Ind AS 17/AS 19) allowed lessees to classify operating leases as off-balance sheet items, which obscured the true financial leverage and asset base of a company. Ind AS 116 addresses this by requiring lessees to recognise assets and liabilities for virtually all lease contracts.

Key Definitions and Concepts

• Lease: A contract (or part of a contract) that conveys the right to use an identified asset (the underlying asset) for a period of time in exchange for consideration. A contract is a lease if it conveys the right to control the use of an identified asset for a period of time.
• Right-of-Use (ROU) Asset: An asset that represents a lessee's right to use an underlying asset for the lease term. It is initially measured at cost and subsequently depreciated.
• Lease Liability: A liability representing a lessee's obligation to make lease payments arising from a lease. It is initially measured at the present value of the lease payments that are not paid at the commencement date.
• Lease Term: The non-cancellable period for which a lessee has the right to use an underlying asset, together with: (a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and (b) periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.
• Discount Rate: The rate used to present value the lease payments. The lessee shall use the interest rate implicit in the lease if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.
• Incremental Borrowing Rate: The rate of interest that a lessee would have to pay to borrow funds over a similar term, and with a similar security, to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.
• Initial Direct Costs: Incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained (e.g., commissions, legal fees). These are included in the initial measurement of the ROU asset.

Lessee Accounting under Ind AS 116

Ind AS 116 mandates a single accounting model for lessees, requiring them to recognise a Right-of-Use (ROU) asset and a Lease Liability for virtually all leases.

Recognition Exemptions

Lessees may elect not to apply the recognition requirements for:

• Short-term leases: Leases with a lease term of 12 months or less at the commencement date, and that do not contain a purchase option.
• Leases of low-value assets: Leases for which the underlying asset is of low value (e.g., personal computers, office furniture, small printers). The threshold for 'low-value' is typically considered around USD 5,000 (or equivalent INR). This assessment is made on an absolute basis, irrespective of the size of the lessee.

Treatment of Exempted Leases: If a lessee applies these exemptions, lease payments are recognised as an expense on a straight-line basis over the lease term or another systematic basis if that is more representative of the pattern of the lessee's benefit.

Initial Measurement

At the commencement date, a lessee shall recognise a ROU asset and a lease liability.

1. Right-of-Use (ROU) Asset

$$\text{Initial Cost of ROU Asset} = \text{Amount of Initial Measurement of Lease Liability} \\ + \text{Any Lease Payments Made at or Before Commencement Date (less any lease incentives received)} \\ + \text{Initial Direct Costs Incurred by the Lessee} \\ + \text{An Estimate of Costs to be Incurred by the Lessee in Dismantling and Removing the Underlying Asset, Restoring the Site on which it is Located or Restoring the Underlying Asset to the Condition Required by the Terms and Conditions of the Lease, unless those costs are incurred to produce inventories.}$$

Journal Entry (Initial Recognition):
Dr. Right-of-Use Asset A/c
Cr. Lease Liability A/c
Cr. Cash/Bank A/c (for initial payments/direct costs)

2. Lease Liability

$$\text{Initial Measurement of Lease Liability} = \text{Present Value of the Lease Payments that are not Paid at the Commencement Date.}$$

Lease Payments Included in Measurement:

• Fixed payments (less any lease incentives receivable)
• Variable lease payments that depend on an index or a rate (initially measured using the index/rate at commencement)
• Amounts expected to be payable by the lessee under residual value guarantees
• The exercise price of a purchase option if the lessee is reasonably certain to exercise that option
• Payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease

Discount Rate: The lease payments are discounted using the interest rate implicit in the lease. If that cannot be readily determined, the lessee's incremental borrowing rate is used.

Subsequent Measurement

1. Right-of-Use (ROU) Asset
After initial recognition, a lessee shall measure the ROU asset using the cost model, unless it applies the revaluation model (Ind AS 16) or fair value model (Ind AS 40) to its property, plant and equipment or investment property, respectively, of the same class.

Cost Model:

• Depreciation: The ROU asset is depreciated over the shorter of the lease term and the useful life of the underlying asset. If the lease transfers ownership of the underlying asset to the lessee by the end of the lease term or the cost of the ROU asset reflects that the lessee will exercise a purchase option, the lessee shall depreciate the ROU asset from the commencement date to the end of the useful life of the underlying asset.
• Impairment: The ROU asset is subject to impairment testing in accordance with Ind AS 36, 'Impairment of Assets'.

Journal Entry (Depreciation):
Dr. Depreciation Expense A/c
Cr. Accumulated Depreciation - ROU Asset A/c

2. Lease Liability
The lease liability is subsequently measured by:

• Increasing the carrying amount to reflect interest on the lease liability (using the effective interest method).
• Reducing the carrying amount to reflect the lease payments made.
• Remeasuring the carrying amount to reflect any reassessment or lease modifications.

Journal Entry (Interest & Payment):
Dr. Finance Cost (Interest Expense) A/c
Dr. Lease Liability A/c (for principal portion of payment)
Cr. Cash/Bank A/c (for lease payment)

Presentation in Financial Statements

• Balance Sheet: ROU assets are presented either within Property, Plant and Equipment or separately. Lease liabilities are presented separately from other financial liabilities.
• Statement of Profit and Loss: Depreciation expense on ROU assets and interest expense on lease liabilities are presented separately. This replaces the single operating lease expense under Ind AS 17.
• Cash Flow Statement: Cash payments for the principal portion of the lease liability are presented within financing activities. Cash payments for the interest portion may be presented within operating, investing, or financing activities (consistent with Ind AS 7). Cash payments for short-term leases, low-value leases, and variable lease payments not included in the lease liability are presented within operating activities.

Lessor Accounting under Ind AS 116

Ind AS 116 substantially carries forward the lessor accounting requirements from Ind AS 17. Lessors continue to classify leases as either finance leases or operating leases.

Lease Classification

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

Indicators of a Finance Lease (one or more usually leads to finance lease classification):

• The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
• The lessee has an option to purchase the underlying asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the commencement date, that the option will be exercised.
• The lease term is for the major part of the economic life of the underlying asset even if title is not transferred.
• At the commencement date, the present value of the lease payments amounts to at least substantially all of the fair value of the underlying asset.
• The underlying asset is of such a specialised nature that only the lessee can use it without major modifications.

Finance Lease Accounting (Lessor)

At the commencement date, a lessor shall recognise assets held under a finance lease in its balance sheet and present them as a receivable at an amount equal to the net investment in the lease.

• Initial Measurement: Net investment in the lease is measured at the amount of the lease receivable plus any initial direct costs incurred by the lessor.
• Subsequent Measurement: Finance income is recognised over the lease term based on a pattern reflecting a constant periodic rate of return on the lessor's net investment in the lease. Lease payments received reduce the gross investment in the lease.

Journal Entry (Initial Recognition):
Dr. Lease Receivable A/c
Cr. Underlying Asset A/c
Cr. Cash/Bank A/c (for initial direct costs)

Journal Entry (Subsequent - Receipt of Payment & Income):
Dr. Cash/Bank A/c
Cr. Lease Receivable A/c (principal portion)
Cr. Finance Income A/c (interest portion)

Operating Lease Accounting (Lessor)

A lessor shall recognise lease payments from operating leases as income on a straight-line basis over the lease term, unless another systematic basis is more representative of the pattern in which benefit from the use of the underlying asset is diminished.

• Underlying Asset: The underlying asset remains on the lessor's balance sheet and is depreciated in accordance with Ind AS 16 or Ind AS 40.
• Initial Direct Costs: Initial direct costs incurred by lessors in negotiating and arranging an operating lease are added to the carrying amount of the underlying asset and recognised as an expense over the lease term on the same basis as the lease income.

Journal Entry (Income):
Dr. Cash/Bank A/c
Cr. Lease Income A/c

Journal Entry (Depreciation):
Dr. Depreciation Expense A/c
Cr. Accumulated Depreciation A/c

Manufacturer or Dealer Lessors

Manufacturer or dealer lessors recognise selling profit or loss in the period of sale, in addition to finance income over the lease term for finance leases. This selling profit or loss is equivalent to the profit or loss on an outright sale of the underlying asset.

• Finance Lease: Recognise selling profit or loss (difference between fair value of asset and its cost/carrying amount) at commencement. Finance income is recognised over the lease term.
• Operating Lease: No selling profit recognised at commencement. Accounted for as a regular operating lease.

Sale and Leaseback Transactions

A sale and leaseback transaction involves an entity (seller-lessee) selling an asset and then leasing back the same asset from the buyer-lessor. The accounting treatment depends on whether the transfer of the asset qualifies as a sale under Ind AS 115, 'Revenue from Contracts with Customers'.

If the Transfer is a Sale (under Ind AS 115)

The seller-lessee measures the ROU asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee. The seller-lessee recognises only the amount of any gain or loss that relates to the rights transferred to the buyer-lessor.

ROU Asset Measurement:

$$\text{ROU Asset} = \text{Previous Carrying Amount of Asset} \times \frac{\text{Present Value of Lease Payments}}{\text{Fair Value of Asset}}$$

Gain or Loss Recognised:

$$\text{Gain/Loss Recognised} = \text{Total Gain/Loss} \times \frac{\text{Rights Transferred}}{\text{Total Rights}} = \text{Total Gain/Loss} \times \left(1 - \frac{\text{Present Value of Lease Payments}}{\text{Fair Value of Asset}}\right)$$

Buyer-Lessor Accounting: The buyer-lessor accounts for the purchase of the asset in accordance with applicable Ind ASs and for the lease in accordance with lessor accounting requirements (finance or operating lease).

If the Transfer is Not a Sale (under Ind AS 115)

If the transfer of an asset by the seller-lessee does not satisfy the requirements of Ind AS 115 to be a sale of an asset:

• Seller-lessee: Continues to recognise the transferred asset and recognises a financial liability equal to the transfer proceeds. It accounts for the financial liability in accordance with Ind AS 109, 'Financial Instruments'.
• Buyer-lessor: Does not recognise the transferred asset and recognises a financial asset equal to the transfer proceeds. It accounts for the financial asset in accordance with Ind AS 109.

Other Important Considerations

Lease Modifications

A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease.

• Separate Lease: Accounted for as a separate lease if (a) the modification increases the scope of the lease by adding the right to use one or more underlying assets, and (b) the consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope.
• Not a Separate Lease: If not a separate lease, the lessee remeasures the lease liability using a revised discount rate and adjusts the ROU asset. If the ROU asset is reduced, a gain or loss is recognised in profit or loss.

Subleases

A sublease is a transaction where a lessee (intermediate lessor) leases out an underlying asset to a third party (sublessee).

• Intermediate Lessor: Classifies the sublease as a finance or operating lease by reference to the ROU asset arising from the head lease, not the underlying asset itself.
• Sublessee: Accounts for the sublease as a new lease in accordance with lessee accounting requirements.

Variable Lease Payments

Variable lease payments that depend on an index or a rate are included in the initial measurement of the lease liability. Other variable lease payments (e.g., linked to sales, usage) are expensed in the period in which the event or condition that triggers those payments occurs.

CA Exam Tip: Only variable payments dependent on an index or rate are part of the lease liability. Others are P&L expenses.

Impact on Financial Ratios

Ind AS 116 significantly impacts financial ratios:

• EBITDA: Increases as operating lease expenses are replaced by depreciation and interest expense.
• Debt-to-Equity Ratio: Increases due to the recognition of lease liabilities.
• Return on Assets (ROA): May decrease due to higher asset base (ROU assets).
• Gearing Ratios: Increase due to higher debt (lease liability).

Disclosure Requirements

Ind AS 116 requires extensive disclosures to provide users of financial statements with a basis to assess the effect that leases have on the financial position, financial performance and cash flows of the entity.

Lessee Disclosures

• Depreciation expense by class of ROU asset.
• Interest expense on lease liabilities.
• Expense relating to short-term leases, low-value asset leases, and variable lease payments not included in lease liability.
• Total cash outflow for leases.
• Additions to ROU assets.
• Gains or losses arising from sale and leaseback transactions.
• Maturity analysis of lease liabilities.
• Significant judgements made in determining the lease term and the discount rate.

Lessor Disclosures

• For finance leases: Reconciliation of the gross investment in the lease and the net investment in the lease, analysis of unearned finance income, maturity analysis of lease receivables.
• For operating leases: Analysis of lease income, maturity analysis of lease payments receivable, information about the underlying assets subject to operating leases.

Indian Specifics and CA Exam Tips

• Transition: Be aware of the transition options (full retrospective or modified retrospective approach). For exam purposes, assume modified retrospective unless specified.
• AS 19 vs Ind AS 116: Understand the fundamental shift for lessees from a dual model (operating/finance) to a single ROU asset and lease liability model.
• Discount Rate: Emphasize the hierarchy: implicit rate first, then incremental borrowing rate. Practice calculating IBR if not given.
• Lease Term: Critical judgement area. Options to extend/terminate are included if 'reasonably certain' to be exercised/not exercised. This often involves significant judgement.
• Variable Lease Payments: Only index/rate-dependent payments are in lease liability. Others are P&L expenses. This is a common trap.
• Sale and Leaseback: Focus on the Ind AS 115 criteria for sale. If it's a sale, understand the proportional gain/loss recognition. If not a sale, it's a financing arrangement.
• Lease Modifications: Distinguish between separate lease accounting and remeasurement of existing lease liability/ROU asset.
• Presentation: Remember the separate presentation of depreciation and interest in P&L, and principal/interest in cash flow statement.
• Numerical Problems: Expect comprehensive problems involving initial measurement, subsequent measurement (amortisation schedules), and potentially lease modifications or sale and leaseback scenarios. Practice creating amortisation schedules for lease liabilities.

Practice Questions

Test your understanding with these exam-style questions. Model answers are provided for self-assessment. These are designed to simulate CA Final Financial Reporting requirements.

Short Form Questions (Conceptual & Numerical)

Q1. Explain the single lessee accounting model introduced by Ind AS 116. How does it differ from Ind AS 17 for lessees?

Model Answer:
Ind AS 116 introduces a single lessee accounting model, requiring lessees to recognise a Right-of-Use (ROU) asset and a corresponding Lease Liability on the balance sheet for virtually all leases. This eliminates the distinction between operating and finance leases for lessees. Under Ind AS 17, operating leases were off-balance sheet, with lease payments expensed on a straight-line basis. Ind AS 116 brings these leases onto the balance sheet, reflecting the lessee's right to use an asset and the obligation to make lease payments, thereby improving transparency and comparability.

Q2. What are the recognition exemptions available to a lessee under Ind AS 116? How are payments for such leases accounted for?

Model Answer:
Lessees may elect not to apply the recognition requirements for:

1. Short-term leases: Leases with a lease term of 12 months or less at the commencement date, and that do not contain a purchase option.
2. Leases of low-value assets: Leases for which the underlying asset is of low value (e.g., personal computers, office furniture).

For both exemptions, lease payments are recognised as an expense on a straight-line basis over the lease term or another systematic basis if that is more representative of the pattern of the lessee's benefit.

Q3. A lessee enters into a lease agreement. The interest rate implicit in the lease cannot be readily determined. What discount rate should the lessee use to measure the lease liability, and how is it determined?

Model Answer:
If the interest rate implicit in the lease cannot be readily determined, the lessee shall use the lessee's incremental borrowing rate. This rate is defined as the rate of interest that a lessee would have to pay to borrow funds over a similar term, and with a similar security, to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.

Q4. Briefly explain the accounting treatment for a sale and leaseback transaction where the transfer of the asset does NOT qualify as a sale under Ind AS 115.

Model Answer:
If the transfer does not qualify as a sale under Ind AS 115, the seller-lessee continues to recognise the transferred asset on its balance sheet and recognises a financial liability equal to the transfer proceeds. It accounts for this financial liability in accordance with Ind AS 109. The buyer-lessor, conversely, does not recognise the transferred asset and instead recognises a financial asset equal to the transfer proceeds, accounting for it under Ind AS 109.

Q5. How does Ind AS 116 impact a lessee's EBITDA and Debt-to-Equity ratio compared to Ind AS 17?

Model Answer:
Under Ind AS 116, operating lease expenses (which were previously deducted before EBITDA) are replaced by depreciation expense on the ROU asset and interest expense on the lease liability. Since depreciation and interest are typically below EBITDA, EBITDA will generally increase. The recognition of lease liabilities on the balance sheet for most leases will increase the Debt-to-Equity ratio, as total liabilities increase while equity may remain unchanged (or decrease if initial ROU asset is less than lease liability).

Case Studies (Comprehensive Scenarios with Full Solutions)

Case Study 1: Lessee Accounting: Initial and Subsequent Measurement with Amortisation Schedule

ABC Ltd. enters into a 5-year lease for a machine on April 1, 2024. Annual lease payments of ₹1,20,000 are payable in arrears, starting March 31, 2025. The machine's useful life is 8 years. ABC Ltd.'s incremental borrowing rate is 10% p.a. The interest rate implicit in the lease cannot be readily determined. Initial direct costs incurred by ABC Ltd. are ₹10,000. Present value factor for 5 years at 10% is 3.7908. Assume no residual value guarantee or purchase option.

Requirements:
(a) Calculate the initial measurement of the Lease Liability and Right-of-Use Asset.
(b) Prepare the amortisation schedule for the lease liability for the entire lease term.
(c) Pass journal entries for the year ended March 31, 2025, and March 31, 2026.

Model Solution:

(a) Initial Measurement:

• Lease Liability: Present Value of 5 annual payments of ₹1,20,000 discounted at 10%.
  Lease Liability = ₹1,20,000 \times 3.7908 = ₹4,54,896
• Right-of-Use Asset: Initial Lease Liability + Initial Direct Costs.
  ROU Asset = ₹4,54,896 + ₹10,000 = ₹4,64,896

(b) Amortisation Schedule for Lease Liability:
(All amounts in ₹)

(c) Journal Entries:

On April 1, 2024 (Commencement Date):
Dr. Right-of-Use Asset A/c ₹4,64,896
Cr. Lease Liability A/c ₹4,54,896
Cr. Bank A/c (for initial direct costs) ₹10,000
(Being recognition of ROU asset and lease liability)

For the year ended March 31, 2025:

1. Depreciation of ROU Asset: (Lease term 5 years, useful life 8 years. Depreciate over shorter, i.e., 5 years)
   Annual Depreciation = ₹4,64,896 / 5 = ₹92,979.20
   Dr. Depreciation Expense A/c ₹92,979.20
   Cr. Accumulated Depreciation - ROU Asset A/c ₹92,979.20
   (Being depreciation charged on ROU asset)

2. Interest Expense: (From amortisation schedule)
   Dr. Finance Cost (Interest Expense) A/c ₹45,490
   Cr. Lease Liability A/c ₹45,490
   (Being interest accrued on lease liability)

3. Lease Payment: (On March 31, 2025)
   Dr. Lease Liability A/c ₹1,20,000
   Cr. Bank A/c ₹1,20,000
   (Being annual lease payment made)

For the year ended March 31, 2026:

1. Depreciation of ROU Asset:
   Dr. Depreciation Expense A/c ₹92,979.20
   Cr. Accumulated Depreciation - ROU Asset A/c ₹92,979.20
   (Being depreciation charged on ROU asset)

2. Interest Expense: (From amortisation schedule)
   Dr. Finance Cost (Interest Expense) A/c ₹38,039
   Cr. Lease Liability A/c ₹38,039
   (Being interest accrued on lease liability)

3. Lease Payment: (On March 31, 2026)
   Dr. Lease Liability A/c ₹1,20,000
   Cr. Bank A/c ₹1,20,000
   (Being annual lease payment made)

Case Study 2: Lessor Accounting: Finance Lease Classification and Accounting

XYZ Ltd. (Lessor) leases a specialized asset to PQR Ltd. (Lessee) on April 1, 2024. Cost of asset to XYZ Ltd. is ₹10,00,000. Fair value at commencement is ₹10,00,000. Lease term is 4 years. Annual lease payments of ₹3,00,000 are payable in advance on April 1 each year. The asset's useful life is 5 years. The interest rate implicit in the lease is 8% p.a. (PV of 4 payments in advance at 8% = 1 + PV of 3 payments in arrears = 1 + 2.5771 = 3.5771). XYZ Ltd. incurred initial direct costs of ₹20,000.

Requirements:
(a) Classify the lease as per Ind AS 116.
(b) Calculate the net investment in the lease.
(c) Prepare the amortisation schedule for the lease receivable for the entire lease term.
(d) Pass journal entries for the year ended March 31, 2025.

Model Solution:

(a) Lease Classification:

• Lease Term: 4 years, which is a major part of the economic life (4/5 = 80%).
• Present Value of Lease Payments: ₹3,00,000 \times 3.5771 = ₹10,73,130.
• Fair Value of Asset: ₹10,00,000.

Since the lease term is for the major part of the economic life and the present value of lease payments (₹10,73,130) is substantially all of the fair value of the asset (₹10,00,000), the lease qualifies as a Finance Lease.

(b) Net Investment in the Lease:
Net Investment in Lease = Present Value of Lease Payments + Initial Direct Costs
Net Investment in Lease = ₹10,73,130 + ₹20,000 = ₹10,93,130

(c) Amortisation Schedule for Lease Receivable:
(All amounts in ₹)

*Last payment adjusted to clear the balance. Total payments received = 3,00,000 * 4 = 12,00,000. Total finance income = 12,00,000 - 10,93,130 = 1,06,870.

(d) Journal Entries for the year ended March 31, 2025:

On April 1, 2024 (Commencement Date):
Dr. Lease Receivable A/c ₹10,93,130
Cr. Asset A/c ₹10,00,000
Cr. Bank A/c (for initial direct costs) ₹20,000
Cr. Unearned Finance Income A/c (balancing figure for PV of payments vs FV of asset) ₹73,130
(Being recognition of finance lease receivable and derecognition of asset)

On April 1, 2024 (Receipt of first lease payment):
Dr. Bank A/c ₹3,00,000
Cr. Lease Receivable A/c ₹3,00,000
(Being receipt of first lease payment in advance)

On March 31, 2025 (Year-end - Recognition of Finance Income):
Dr. Lease Receivable A/c ₹63,450
Cr. Finance Income A/c ₹63,450
(Being recognition of finance income for the year)

Case Study 3: Sale and Leaseback: Accounting when Transfer is a Sale

On April 1, 2024, Delta Ltd. (seller-lessee) sells a building with a carrying amount of ₹50,00,000 to Gamma Ltd. (buyer-lessor) for its fair value of ₹60,00,000. Immediately, Delta Ltd. leases back the building for 10 years. Annual lease payments of ₹7,00,000 are payable in arrears. Delta Ltd.'s incremental borrowing rate is 8% p.a. (PV factor for 10 years at 8% = 6.7101). The transfer qualifies as a sale under Ind AS 115.

Requirements:
(a) Calculate the gain or loss to be recognised by Delta Ltd. on the sale.
(b) Calculate the initial measurement of the ROU asset for Delta Ltd.
(c) Pass journal entries for Delta Ltd. on April 1, 2024, and March 31, 2025 (for first lease payment and related expenses).

Model Solution:

(a) Gain or Loss on Sale:

• Sale Price (Fair Value) = ₹60,00,000
• Carrying Amount = ₹50,00,000
• Total Gain on Sale = ₹60,00,000 - ₹50,00,000 = ₹10,00,000

(b) Initial Measurement of Lease Liability and ROU Asset:

• Lease Liability: Present Value of 10 annual payments of ₹7,00,000 discounted at 8%.
  Lease Liability = ₹7,00,000 \times 6.7101 = ₹46,97,070

• ROU Asset: Proportion of previous carrying amount retained.
  Proportion of rights retained = \frac{\text{PV of Lease Payments}}{\text{Fair Value of Asset}} = \frac{46,97,070}{60,00,000} = 0.782845
  ROU Asset = Previous Carrying Amount \times Proportion of rights retained
  ROU Asset = ₹50,00,000 \times 0.782845 = ₹39,14,225

• Gain Recognised on Sale: The gain recognised is only for the rights transferred to the buyer-lessor.
  Proportion of rights transferred = 1 - Proportion of rights retained = 1 - 0.782845 = 0.217155
  Gain Recognised = Total Gain \times Proportion of rights transferred
  Gain Recognised = ₹10,00,000 \times 0.217155 = ₹2,17,155

  The unrecognised gain (₹10,00,000 - ₹2,17,155 = ₹7,82,845) is effectively embedded in the ROU asset, meaning the ROU asset is recognised at a lower value than if it were a new lease.

(c) Journal Entries for Delta Ltd.:

On April 1, 2024 (Commencement Date):

1. Sale of Building:
   Dr. Bank A/c ₹60,00,000
   Cr. Building A/c ₹50,00,000
   Cr. Gain on Sale of Building A/c ₹10,00,000
   (Being sale of building at fair value)

2. Recognition of ROU Asset and Lease Liability:
   Dr. Right-of-Use Asset A/c ₹39,14,225
   Dr. Gain on Sale of Building A/c (to reduce total gain) ₹7,82,845
   Cr. Lease Liability A/c ₹46,97,070
   (Being recognition of ROU asset and lease liability, and adjustment of gain on sale)

For the year ended March 31, 2025:

1. Depreciation of ROU Asset: (Lease term 10 years, useful life of building usually longer. Depreciate over lease term)
   Annual Depreciation = ₹39,14,225 / 10 = ₹3,91,422.50
   Dr. Depreciation Expense A/c ₹3,91,422.50
   Cr. Accumulated Depreciation - ROU Asset A/c ₹3,91,422.50
   (Being depreciation charged on ROU asset)

2. Interest Expense: (Lease Liability at 1.4.2024 = ₹46,97,070)
   Interest Expense = ₹46,97,070 \times 8% = ₹3,75,765.60
   Dr. Finance Cost (Interest Expense) A/c ₹3,75,765.60
   Cr. Lease Liability A/c ₹3,75,765.60
   (Being interest accrued on lease liability)

3. Lease Payment: (On March 31, 2025)
   Dr. Lease Liability A/c ₹7,00,000
   Cr. Bank A/c ₹7,00,000
   (Being annual lease payment made)

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Common Mistakes & CA Exam Tips

• Incorrect Discount Rate: Using the wrong discount rate (e.g., lessee's IBR when implicit rate is readily determinable, or vice versa).
• Lease Term Judgement: Misinterpreting 'reasonably certain' for extension/termination options.
• Variable Lease Payments: Including all variable payments in lease liability, instead of only index/rate-dependent ones.
• Sale and Leaseback: Failing to apply Ind AS 115 criteria for 'sale' or incorrectly calculating the recognised gain/loss and ROU asset.
• Amortisation Schedule Errors: Mistakes in calculating interest or principal repayment, especially with advance payments.
• Presentation: Not separating depreciation and interest in P&L, or principal and interest in cash flow statement.
• Transition Impact: Overlooking the impact of transition adjustments if specifically asked in a problem.
• Practice Tip: Focus heavily on numerical problems involving amortisation schedules, initial and subsequent measurement, and sale and leaseback. Understand the logic behind each step, not just memorising formulas.

Key Takeaways

• Ind AS 116 fundamentally changes lessee accounting by bringing most leases onto the balance sheet, enhancing transparency.
• Lessees recognise a Right-of-Use (ROU) asset and a Lease Liability, subject to short-term and low-value exemptions.
• Lessor accounting largely remains unchanged, classifying leases as finance or operating.
• The discount rate (implicit or incremental borrowing rate) and lease term determination are critical judgements.
• Sale and leaseback transactions require careful assessment under Ind AS 115 to determine if a sale has occurred.
• The standard significantly impacts financial statements and key ratios, which must be understood for analysis.

Frequently Asked Questions (FAQs)

Q: What is the main change introduced by Ind AS 116 for lessees?
A: Ind AS 116 requires lessees to recognise a Right-of-Use (ROU) asset and a Lease Liability on the balance sheet for almost all leases, eliminating the distinction between operating and finance leases for lessees.

Q: What discount rate should a lessee use under Ind AS 116?
A: The lessee should use the interest rate implicit in the lease if it can be readily determined. Otherwise, the lessee's incremental borrowing rate should be used.

Q: How is the ROU asset depreciated under Ind AS 116?
A: The ROU asset is depreciated over the shorter of the lease term and the useful life of the underlying asset. If ownership transfers or a purchase option is reasonably certain to be exercised, it's depreciated over the useful life of the underlying asset.

Q: Does Ind AS 116 change lessor accounting?
A: No, lessor accounting under Ind AS 116 is substantially similar to Ind AS 17, retaining the classification of leases as either finance or operating leases.

Q: What is the impact of Ind AS 116 on EBITDA?
A: Ind AS 116 generally increases EBITDA for lessees because operating lease expenses (which were previously deducted before EBITDA) are replaced by depreciation and interest expense, both of which are typically recognised below EBITDA.

References & Further Reading

• Ind AS 116 – Leases (ICAI)
• Ind AS 115 – Revenue from Contracts with Customers (ICAI)
• Ind AS 109 – Financial Instruments (ICAI)
• Ind AS 16 – Property, Plant and Equipment (ICAI)
• ICAI Study Material / RTPs / MTPs for CA Final Financial Reporting
• IFRS 16 – Leases (for global context)

Last Updated: July 2026 | Prepared by Kartavvya CA Expert Team (aligned with latest ICAI syllabus & Ind-AS)

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