9 MAY 2019 -WEBCAST AS 116 - CG... · Total Liabilities 38,750 53,250 Rs.in Lakhs Impact on • Debt to Equity • ROI • Asset Coverage • Current Ratio • Business valuations

IND AS 116, LEASES –A PRACTICAL APPROACH

9 MAY 2019 - WEBCAST

Ind AS Implementation Group

Accounting Standards Board

The Institute of Chartered Accountants of India,

New Delhi, India

ICAI

DISCLAIMER

The views expressed by the presenter are his personal views and based on

professional judgements

The views of the presenter may not be construed as the conclusions or

opinions of the Ind AS Implementation Group or the Accounting Standards

Board or that of the Institute of Chartered Accountants of India

Due care and professional judgements may be exercised by the audience in

applying the requirements of the Standard

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ICAI

STRUCTURE OF THE DISCUSSION

3

A snap shot of the

Standard

Key

Impact AreasCase

Study

Practical

expedients

Transitional

ProvisionsThe

Next Steps

ICAI

A SNAPSHOT OF THE STANDARD

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Erstwhile Ind AS 17 Ind AS 116

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 contract, or part of a contract, that

conveys the right to use an asset (the

underlying asset) for a period of time in

exchange for consideration.

Future lease payments in respect of

operating leases are off balance sheet

items

Right of use Asset is recognised with

corresponding Lease liability in the

balance sheet for all operating leases

Operating lease payments are charged to

the profit and loss as expense on a

straight line basis

Depreciation (on Right of use Assets) and

finance costs (on Lease Liability) to be

recognised in the financial statements of

the Lessee

ICAI

HOW IT LOOKS LIKE?

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Assets Under Ind AS 17 Under Ind AS 116

Total existing assets 38,750 38,750

Right of use assets NA 14,500

Total Assets 38,750 53,250

Balance Sheet

Equity and Liabilities Under Ind AS

17

Under Ind AS 116

Total existing equity

and liabilities

38,750 38,750

Lease Liability NA 14,500

Total Liabilities 38,750 53,250

Rs.in Lakhs

Impact on

• Debt to Equity

• ROI

• Asset Coverage

• Current Ratio

• Business

valuations

• Impact on loan

covenants

ICAI

HOW IT LOOKS LIKE?

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Particulars Under I

nd AS 17

Under

Ind AS 116

Profit before lease

accounting

7421 7421

Operating lease expenses (451) NA

Low value/ short term

leases

NA (98)

EBITDA 6,970 7,323

Depreciation on ROU asset NA (1,450)

Finance cost on Lease

Liability

NA (145)

Profit for the period 6,970 5,728

Statement of profit and loss Rs.in Lakhs

Impact on

• EBITDA

• Interest Cover

• Free cash accruals

• Front loading of

expenses

• PBT in initial years

• Operating cash flow

• Financing cash flow

ICAI

IDENTIFYING A LEASE

Is it a lease?

Assessment to be at inception

Re-assess only if terms and

conditions of contract changed

Identified AssetRight to control the use

of an identified asset&

Right to obtain

substantially all

economic benefits from useRight to direct the use

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POINTS TO PONDER

• Accounting for bundled contract containing both lease and provision of

services by Lessees

• When the supplier has a substantive substitution right

• If exists, there is no identified asset

• Substitution of the asset during repairs or maintenance periods does not,

represent a substantive right of substitution

• The ability to substitute if new technology becomes available does not

represent a substantive right of substitution

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IDENTIFIED ASSET

Portion of Identified

asset?

Physically distinct

portionCapacity portion

Substantially all the

capacity?A minimal portion of the

capacity

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LEASE TERM

Initial lease period

Reassess and revise estimate of Lease Term at every reporting period

based on facts and circumstances

Reasonably certain

that the option to

extend will be

elected

Reasonably certain

that the option to

terminate will be

elected

Extension and Termination options to be

considered in determining the lease term

ICAI

POINTS TO PONDER

The entity will need to consider all relevant facts and circumstances that create an

‘economic incentive’ for the lessee to exercise the option to extend a lease or

terminate it

• Contractual terms for optional periods and market rates

• Significant leasehold improvements

• Costs of termination and return

• Importance to operations (specialised, location, alternatives)

• Conditionality associated with option

ICAI

INITIAL MEASUREMENT

Right of use asset

(At cost)

Discount the lease payments to arrive at the present value of right of

use asset/ lease liability

At the commence of lease, recognise right of use

asset and lease liability

Lease Liability

(PV of lease payments)

ICAI

DISCOUNT RATE

Interest rate implicit in the

lease

Use rate implicit in the lease or Incremental borrowing rate

Incremental borrowing rate of

the lessee

Lease payments shall be discounted using

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POINTS TO PONDER

• Can an entity directly use incremental borrowing rate as the discount rate?

• Implicit interest rate requires fair value of underlying asset and initial direct cost

incurred by the Lessor

• Significant judgements involved in determining incremental borrowing rate

• Similar term

• Similar security

• Similar fund required to be borrowed in a similar economic environment

• Adjustment factors may include (a) Lease Term (b) Repayment profile (c)

Credit Risk (d) Loan Security

ICAI

SUBSEQUENT MEASUREMENT

Right of Use Asset

• Apply depreciation requirements in

Ind AS 16

• Depreciate over the useful life

(taking extension options into

consideration)

• Test for Impairment under Ind AS

36, if indicators are existing

• Increase the lease liability to reflect

the interest

• Decrease the lease liability to reflect

payments made

Lease Liability

ICAI

CASE STUDY IN THE LESSEE’S

ACCOUNTS UNDER IND AS 116

ABC, the manufacturing company, needs to adopt the new standard Ind AS 116 Leases in

the reporting period ending 31 March 2020.

During the preparatory works, ABC discovered that the operating lease contract related to a

machine might require some adjustments.

ABC entered into the contract on 1 April 2017 for 5 years, annual rental payments are

Rs.1.25 Lakhs in arrears (that is, 31 March each year) and at the end of the lease term, the

machine will be returned back to the lessor. The economic life of a machine is 10 years.

How can ABC restate the contract under Ind AS 116 using both full retrospective and

modified retrospective approach?

Use the discount rate of 10%.

1

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CALCULATION OF PRESENT VALUE

OF LEASE PAYMENTS

1

7

Year ending Lease

payments

Discount factor Present value of

lease payments

31-03-2018 1,25,000 0.9091 1,13,636

31-03-2019 1,25,000 0.8264 1,03,306

31-03-2020 1,25,000 0.7513 93,914

31-03-2021 1,25,000 0.6830 85,377

31-03-2022 1,25,000 0.6209 77,615

Total 6,25,000 4,73,848

Note: Discount factor in the first year is calculated as 1/((1+10%) to the power of year 1), etc.

The right of use asset equals to the lease liability at the commencement date, plus lessee’s

initial direct costs, plus some other things – but in this case, we have nothing like that, so let’s

just say it’s the same as the lease liability.

ICAI

JOURNAL ENTRY

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Under Ind AS 116, the initial journal entry would be

Date Particulars Debit Credit

1 April 2018 Right to use asset a/c Dr 4,73,848

To Lease liability a/c 4,73,848

Subsequently, ABC needs to take care about 2 things:

1. Depreciation of the ROU asset: Let’s say it’s straight line over the lease term of 5

years, thus it’s Rs. 94,770 per year (Rs. 4,73,848/5).

2. Lease payments: Each lease payment of Rs.1,25,000 is split between the repayment of

the lease liability and interest.

ICAI

CALCULATION FOR SPLITTING OF LEASE

LIABILITY AND INTEREST ON REPAYMENT

1

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Year ending Lease

liability

b/f (A)

Lease

payment

Interest

(B = A*10%)

Decrease in

lease liability

(C = 1,25,000 - B)

Lease

Liability c/f

(D = A - C)

31-03-2018 4,73,848 1,25,000 47,385 77,615 3,96,223

31-03-2019 3,96,223 1,25,000 39,623 85,377 3,10,857

31-03-2020 3,10,857 1,25,000 31,086 93,914 2,16,942

31-03-2021 2,16,942 1,25,000 21,694 1,03,306 1,13,636

31-03-2022 1,13,636 1,25,000 11,364 1,13,636 0

Total 6,25,000 1,51,152 4,73,848

ICAI

PORTFOLIO APPLICATION

All leases in the portfolio

have similar

characteristics

No material changes is

expected from applying

this Standard to the

individual leases within

that portfolio

Entity shall use estimates and assumptions that reflect the size and

composition of the portfolio.

Standard may be applied for a portfolio of leases

ICAI

LOW VALUE ASSETS

For leases for which the underlying asset is of

low value, entity may apply Para 6 of Ind AS 116

Lease payments associated with

those leases are accounted as

an expense

Either on a straight-line basis

over the lease term or another

systematic basis

Option can be applied on a lease by lease basis

If a lessee subleases an asset, or expects to sublease an asset, the

head lease does not qualify as a lease of a low-value asset

ICAI

SHORT TERM LEASES

Lease payments associated

with those leases are

accounted as an expense

Either on a straight-line basis

over the lease term or another

systematic basis

A lease that contains a purchase option is not a short-term lease

A lease that, at the commencement date, has a

lease term of 12 months or less

Option can be applied only based on class of underlying asset

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TRANSITIONAL PROVISIONS

Full retrospective

approach

Modified retrospective

approach

A first time adopter of this Standard shall apply

either

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FULL RETROSPECTIVE APPROACH

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ABC adopts Ind AS 116 in its financial statements for the year ending 31 March

2020, and that means that the transition date is 1 April 2018.

We need to restate all numbers for the comparative period, too.

1.Restatement of opening balances of the earliest period presented (that is: Before

1 April 2018):

a) Recognizing ROU asset and lease liability:


01-04-2018 Right to use asset a/c Dr 4,73,848


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(CONTINUATION)

25

b) Reversal of the lease payments before 1 April 2018 under Ind AS 17 (there was just one):


01-04-2018 Cash a/c Dr 1,25,000

To Retained earnings a/c 1,25,000

c) Accounting for the lease payments before 1 April 2018 under Ind AS 116 (there was just one):


01-04-2018 Lease liability a/c Dr 77,615

Retained earnings a/c Dr 47,385

To Cash a/c 1,25,000

ICAI


(CONTINUATION)

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d) Accounting for the depreciation of the ROU asset before 1 April 2018 under Ind AS 116 (there was just one year):


01-04-2018 Retained earnings (equity) a/c Dr 94,770

To Right of use asset a/c 94,770

ICAI


(CONTINUATION)

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All 4 entries can be combined in one adjustment and it would look something like:


01-04-2018 Right of use asset a/c Dr

(4,73,848 less depreciation of 94,770)

3,79,079

Retained earnings a/c Dr

(-1,25,000+47,385+94,770, or see table 3 for the year 2018)

17,154

To Lease liability a/c

(4,73,848 less the lease liability repayment of

77,615, or see table 2 for the year 2018)

3,96,233

ICAI


(CONTINUATION)

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2. Restatement of the comparative period (year ended March 31, 2019):


31-03-2019 Lease Liability a/c Dr 85,377

Interest (profit or loss for the year ended 31, March 2019) 39,623

Depreciation (profit or loss for the year ended 31, March

2019)

94,770

To Right to use asset a/c 94,770

To Operating lease expenses (profit or loss for the

year ended 31, March 2019)

1,25,000

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(CONTINUATION)

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3. Restatement of the current period (year ending March 31, 2020):


31-03-2020 Lease Liability a/c Dr 93,914

Interest (profit or loss for the year ending 31, March

2020)

31,086

Depreciation (profit or loss for the year ending 31, March

2020)

94,770


To Operating lease expenses (profit or loss for the

year ending 31, March 2020)

1,25,000

ICAI

FULL RETROSPECTIVE APPROACH –

STATEMENT OF FINANCIAL POSITION

(EXTRACT)

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Statement of financial position (extract)

Particulars March 31,

2020

March 31, 2019

(restated)

01-04-2018

(restated)

ROU asset 1,89,539 2,84,309 3,79,079

Equity – accumulated profit

(effect of restatement)

27,403 26,548 17,155

Lease liability

Long term 1,13,636 2,16,942 3,10,857

Short term 1,03,306 93,914 85,377

2,16,942 3,10,857 3,96,233

ICAI

FULL RETROSPECTIVE APPROACH –

STATEMENT OF COMPREHENSIVE

INCOME (EXTRACT)

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Statement of comprehensive income (extract)

Particulars March 31, 2020 March 31, 2019

(restated)

Depreciation of ROU asset 94,770 94,770

Interest (lease liability) 31,086 39,623

ICAI

MODIFIED RETROSPECTIVE

APPROACH

32

Under the modified approach, ABC needs to make an equity adjustment on 1 April 2019 –

that is at the beginning of the current reporting period.

Comparative numbers remain the same as presented before – so no restatement.

This is a way easier method to apply than the full retrospective approach, because you do

not restate the previous years’ numbers.

However, the price for this relief is lower comparability.

It is quite difficult to compare current year under Ind AS 116 with the previous year under Ind

AS 17 and it does not say much about how your leases developed.

ICAI

MODIFIED RETROSPECTIVE

APPROACH – JOURNAL ENTRIES

33

1. Restatement of opening balances at 1 April 2019:

a) Recognizing ROU asset and lease liability:


1-04-2019 Right to use asset a/c Dr 4,73,848


ICAI

MODIFIED RETROSPECTIVE APPROACH –

JOURNAL ENTRIES (CONTINUATION)

34

b) Reversal of the lease payments before 1 April 2019 under Ind AS 17 (there was two):


1-04-2019 Cash a/c Dr 2,50,000

To Retained earnings a/c 2,50,000

c) Accounting for the lease payments before 1 April 2019 under Ind AS 116 (there was two):


1-04-2019 Lease liability a/c Dr 1,62,992

Retained earnings a/c Dr 87,008

To Cash a/c 2,50,000

ICAI



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d) Accounting for the depreciation of the ROU asset before 1 April 2019 under Ind AS 116 (there were two years):


1-04-2019 Retained earnings (equity) a/c Dr 1,89,539

To Right of use asset a/c 1,89,539

ICAI



36

Similarly as with the full approach, we can make one aggregate entry instead of these four:


01-04-2019 Right of use asset a/c Dr

(4,73,848 less depreciation of 94,770*2)

2,84,309

Retained earnings a/c Dr

(-2,50,000+87,008+1,89,539, or see table 3 for the years

2018 and 2019)

26,548

To Lease liability a/c

(4,73,848 less the lease liability repayments of

77,615 and 85,377, or see table 2 for the years 2018

and 2019)

3,10,857

ICAI



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2. Restatement of the current period (year ending March 31, 2020):


Lease Liability a/c Dr 93,914

Interest (profit or loss for the year ending 31, March 2020) 31,086

Depreciation (profit or loss for the year ending 31, March

2020)

94,770


To Operating lease expenses ((profit or loss for the

year ending 31, March 2020)

1,25,000

ICAI


STATEMENT OF FINANCIAL POSITION

(EXTRACT)

38

Statement of financial position (extract)

Particulars March 31,

2020

March 31,

2019

ROU asset 1,89,539 0

Equity - accumulated profit

(effect of restatement)

27,403 0

Lease liability

Long term 1,13,636 -

Short term 1,03,306 -

2,16,942 -

ICAI


STATEMENT OF COMPREHENSIVE

INCOME (EXTRACT)

39

Statement of comprehensive income (extract)

Particulars March 31, 2020 March 31, 2019

Operating lease expenses - 1,25,000

Depreciation of ROU asset 94,770 -

Interest (lease liability) 31,086 -

ICAI

KEY IMPACTS – A RECAP

4

0

Profit in the initial

years of leaseEBITA

Return on capital

employed

Net debt and

gearing ratioCurrent RatioNet assets

Asset retirement

obligation

Volatility of profit

or loss

Need for

renegotiating

lease contracts

ICAI

NEXT STEPS

• Impact assessment of the new

Standard as a lessee

• Decide on Transitional Options

• Create stakeholders’ awareness,

especially in respect of listed

companies

• Applying the Standard for June 2019

quarter

• Whether any contracts has to be

renegotiated

ICAI

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Documents

9 MAY 2019 -WEBCAST AS 116 - CG... · Total Liabilities 38,750 53,250 Rs.in Lakhs Impact on • Debt to Equity • ROI • Asset Coverage • Current Ratio • Business valuations