Accounting for Leasing Transactions: IndAS 116 and IFRS 9

Accounting for Leasing Transactions:IndAS 116 and IFRS 9

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VINOD KOTHARI ON IND AS 116 | JANUARY, 2019 2

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Coverage of this presentation

Expected credit loss model on lease transactions

Accounting of lease transactions under Ind AS 116

Meaning of lease and scope of Ind AS 116

Introduction to Ind AS 116/ IFRS 16


Implementation of Ind AS 116 Ind AS 116 is the Indian adaptation of IFRS 16

Globally Ind AS 116 has been introduced with effect from 1st January, 2019

In India, ICAI issued an Exposure Draft in 2017 and kept it open for public comments However, the same has not been notified yet

Notification needs to come by way of amendment to Accounting Standards Rules, 2015

If notified timely, the standard will come into force with effect from 1st April, 2019


Implementation of IFRS 16 in different countries

Country Effective date of implementation of IFRS 16

Comments, if any

New Zealand 1st January, 2019 -

South Africa 1st January, 2019 -

Singapore 1st January, 2019 -

Australia 1st January, 2019 -

Indonesia 1st January, 2020 In the form of PSAK 73

Japan 1st January, 2019 ASBJ adopted IFRS 16 unmodified as JMIS

Canada 1st January, 2019 -

United States - FASB is not implementing IFRS 16


Meaning of lease as per Ind AS 116 (1/2)Conveys to the lessee the right to control the use of an identified asset for a consideration

Key words

◦ Conveys the right:

◦ Idea is that the right is transferred, not merely granted

◦ Right is right of controlling the use:

◦ Exclusivity of use or control by the lessee

◦ Asset must be an identified asset:

◦ “the asset” instead of “an asset”

◦ Consideration

Service contracts, capacity share contracts, etc.:

◦ If control over right of use is exclusive with the lessee, the contract will most likely amount to a lease

◦ If the lessor uses the asset for the benefit of the lessee, the contract may not be a lease

◦ Asset operated by lessor, but exclusively on the directions of the lessee, it may still be a lease


Identified assetsAgreements to provide an asset, rather than a specific asset, may not fall under the definition of lease at all

This is based lessor’s practical ability to substitute the asset, and such substitution is beneficial to the lessor [para B14]

A substitution right/obligation will not so qualify if

◦ it is contingent – for example, the asset is broken down

◦ It is exercisable only after a certain period

◦ The keyword is – the substitution right should be available throughout the lease term

By default, the right of substitution will not be regarded as substantive [para B 19]


Meaning of lease as per Ind AS 116 (2/2)

Lease

Fulfillment of contract depends upon use of identified asset

Conveys right to control the use of identified asset

Direct the use of the identified assetDerive the benefits from the use of

the identified asset

Contract satisfying twin conditions

Control established when both conditions are satisfied


Recognising a transaction as lease under IndAS 116

Short term Lease

Is lease term more

than 12 months

Other than short term lease

Yes

No

Adherence to the Standard is optional;

the transaction may be expensed as a revenue

item

Recognition of the right to use and lease liability is compulsory. No option exists.

Low value assetsOther than

low value assets


Significant changes in the meaning of leaseEarlier, uncertainty prevailed about capacity sharing contracts such as IRU contracts

For examining the presence of lease in a transaction, IFRIC 4 had to be referred to

Ind AS 116 has provided clarity in this regard -

◦ Para B20 provides that a lease is a lease of identified asset if the asset is physically distinct (for example, floor of a building)


Low value assets – meaning The purpose of the Standard giving a carve out is to focus on

materiality

Illustratively, assets of upto $ 5000 have been regarded as low value

Value is value when the asset is new

The election is based on lease-by-lease basis

Para 8

This, however, does not imply asset-by-asset analysis

Several assets under a single lease should be bunched together

If the asset is meant for sub-lease, the head lease shall not qualify to be a low value asset lease

Examples of low value assets

Stand alone furniture

Computers

Office equipments, telephones, etc.

Asset will be of low value only if:

The lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee

The underlying asset is not highly dependent on, or highly interrelated with, other assets


Short term leasesShort-term leases upto 12 months “lease tenure” are excluded from the Standard

Lease tenure includes the right to renew, if it is reasonably certain that the right will be exercised [Para 18]. Para B37 lists several factors that need to be taken into consideration to determine the certainty of renewal

For example:◦ A lease is for a term of 12 months; if terminated at the end of 12 months, lessee will pay termination

fee

◦ A lease is for a term of 48 months, with a cancellation option at the end of 12 months, and a bargain purchase option at the end of 48 months

Generally speaking, if the lessor has rentalised the 12 months’ rentals based on fair estimate of the residual value at the end of 12 months, the lessor is exposed to RV at the of 12 months.

◦ Such lease is likely to qualify as a short tenure lease

There is no issue in renewal of a lease at the end of 12 months as such lease is a new lease [inferred from para 7]


Meaning of financial lease and operating lease The meaning of financial lease and operating lease remains same under Ind AS 116

Finance lease: A lease under which the risks and rewards of ownership are transferred to lessee. Operating lease is any lease other than a finance lease.

Indicators of a financial lease:◦ Full payout test -present value of minimum lease payments recover 90% of fair value

◦ Transfer of title test

◦ Bargain purchase option test

◦ Lease term test - lease term is more than 75% of estimated economic life of the asset

◦ The equipment is specialized

Additional parameters:◦ Cancellation losses are borne by the lessee

◦ Changes in fair value of residual asset is borne by the lessee

◦ Bargain renewal option


Impact of Ind AS 116 in Accounting

Drastic changes in the Lessee’s books of accounts

All leases come on the balance sheet;

However, not at the full value of the asset

The extent of off-balance sheet asset will depend on

the RV exposure of the lessor

To a limited extent, the difference between leases that transfer ownership or carrying bargain purchase option still remains – para

32


Determination of whether the rights under a contract lead to a lease – paras 9-11

Contract of the lease transfers the following rights to the Customer

Right to obtain economic benefits from the asset

Right to direct the use of the asset

Right to direct the manner and purpose of use of asset

Where the manner and purpose of use of the asset is predetermined

Right to use the asset without supplier’s intervention

Designing of the asset by the customer in a manner which determines the

manner and purpose of use of asset


Lessor accounting under Ind AS 116Particulars Accounting treatment

Finance lease Recognition of the asset –

Assets held under finance lease to be presented as a receivable at an amount equal to the net investment

in the lease.

Recognition of the income –

Finance income over the lease term, based on a pattern reflecting a constant periodic rate of return on

the lessor’s net investment in the lease.

Operating lease Recognition of the asset –

Assets held under operating lease shall have to be capitalised in the books.

Recognition of the income –

The lease payments from operating leases shall have to be recognised as income on either a straight-line

basis or another systematic basis. The lessor shall apply another systematic basis if that basis is more

representative of the pattern in which benefit from the use of the underlying asset is diminished.

Recognition of expenses –

The expenses associated with earning of lease income, like depreciation, shall have to be recognised as

expense.


Lessee accounting under Ind AS 116 (1/3)

Particulars Accounting treatment

Right-to-use

asset

Initial Recognition and treatment –

On the date of commencement of lease, a lessee shall measure the right-of-use (ROU) asset at Present

value of the lease payments discounted at the interest rate implicit in the lease or the incremental

borrowing rate

Subsequent measurement and treatment –

The ROU asset will be depreciated as per the depreciation requirements in IAS 16 Property, Plant and

Equipment

o If ownership of the assets will be transferred to the lessee by the end of the lease term or if there isa certainty that the purchase option will exercised by the lessee, the ROU asset will be depreciatedover the useful life of the asset

o In any other case, the ROU asset will be depreciated over the useful life of the asset or the leaseterm whichever is shorter.

Depreciation on the ROU asset will be reflected as a charge in the income statement


Lessee accounting under Ind AS 116 (2/3)

Particulars Accounting treatment

Lease liability Initial Recognition and treatment

On the date of commencement of lease, a lessee shall measure the lease liability at Present value of the

lease payments discounted at the interest rate implicit in the lease or the incremental borrowing rate

Subsequent measurement and treatment

o The carrying amount of the lease liability will increase by the amount of interest accrued on the lease

liability

o The carrying amount will be reduced on account of the payments made towards the lease liability.

o The interest expense on lease liability, being a component of finance cost will be presented separately

as a charge in the income statement

Exemptions At the option of the lessee, he may choose not to apply the accounting requirement under IFRS – 16 to

the following –

o Short term leases (i.e. leases for a period of 12 months or less)

o Leases of low value assets (for e.g. personal computer)

o Lease payments made for the aforesaid lease of assets will be reflected as an expense, either on

straight line basis over the lease term or any other systematic basis, in the income statement


Lessee accounting under Ind AS 116 (3/3)Particulars Accounting treatmentRenewal/

Modification

Any lease modification to be accounted for as a separate lease if –

o the modification increases the scope of the lease by way of addition of ROU of one or more assets and

o there is a corresponding increase in the consideration for lease for increase in scope

If the lease modification is not accounted for as a separate lease, the accounting treatment for the same will be as

under –

o The consideration in respect of the modified lease will be allocated between lease and non-lease component if any.

o Alternatively, the lessee may choose not to allocate the consideration between lease and non-lease component and

instead account for the entire modification as a lease component.

o The lease liability to be remeasured by discounting the revised lease payments using a revised discount rate, which is

either the interest rate implicit in the lease or lessee’s incremental borrowing rate at the date of modification.

If the modification results in a reduction in the scope of lease, the following treatment need to be done –

o The carrying amount of the ROU asset to be reduced

o Profit/loss on account of reduction in scope of lease to be recognised in profit and loss account

o The lease liability to be remeasured in the same manner as done in case of an increase in scope of lease on account

of lease modification


Subsequent measurement in the books of the lessee

Subsequent measurement

Right of use asset

Cost model – measured at cost reduced by:

Any accumulated depreciation and

impairment losses

Adjusted for any re-measurement of the

lease liability

Measurement model (IndAS 16: PPE)

Lease liability

Similar to financial liability –account for under EIR method

Increase the carrying amount to reflect interest on lease

liability

Reducing carrying amount to reflect lease payments

Adjustments for re-measurement of

lease


Snapshot of Ind AS 116

Lease accounting

Lessor

Financial lease

Treat as receivables

Operating lease

Treat as fixed asset and depreciation is

to be charged

Lessee

Short tenure (Upto 12 months)

At the option of the lessee, lease payments will

be treated as expense

Long tenure

Recognised as right of use asset

If lease transfers ownership or there is certainty of exercise of purchase option –depreciation charged over the useful life

of the asset

If no transfer of ownership, asset to be depreciated from lease commencement date till earlier of – end of useful life or

end of lease term

Obligation to pay lease payments in the liability side


Transitioning provisions Grandfathering is applicable only for determination of whether a contract is a

lease

That is, for contracts which were leases under IAS 17◦ If operating lease, on initial application, lessee is required to bring RTU asset and OTP liability

◦ Treatment is the same as change in accounting policy – requiring restatement of opening position

Alternatively, an en-bloc alternative is allowed, by adjusting the cumulative effect of applying the standard


Computing the discounted value of lease rentalsThe Standard, from lessee perspective, uses the term “lease payments”, which is similar to “minimum lease payments” under the existing standards.

The present value of lease rentals, in case of the lessee, is based on◦ Lease components only, keeping non-lease components outside, unless the lessee elects to combine the

two

Since a lease is conveying the right of use, the consideration pertaining to something which is not for the right to use may be regarded as non-lease component

◦ Maintenance charges

◦ Insurance charges

For being treated as non-lease components◦ The component must not be pertaining to right to use

◦ Must be independent of the right to use, with the lessee having the option of acquiring such components from any vendor

◦ The lessor does not bundle the invoice – segregating the non-lease component


Lease paymentsThe cost of RoU asset at the inception is the “present value” of “lease payments”

3 factors need to be considered◦ Identify non-lease components and separate them

◦ Identify lease payments◦ Lease payments include variable lease rentals if the same are based on an index or a rate

◦ Rates mean market rates

◦ Option to buy if the same is reasonably certain to be exercised

◦ Termination penalties

◦ Any expected payment under a residual value guarantee

◦ Find out the appropriate discounting rate to use◦ Lessor’s implicit rate of return

◦ If the same is not ascertainable from lessee perspective, the lessee’s incremental borrowing cost

◦ Generally speaking, the RoU asset and OTP liability will be equal◦ Exception would be cases where the RoU asset is depreciated over the useful life


Lease termLease term includes the contracted term

◦ If there is an option to terminate, which can be exercised at no more than insignificant penalty, the contract is the period upto such termination option

Termination option is considered when it is option with the lessee◦ Option with the lessor is not recognised [B 36]

The term will include the right of renewal which is reasonably certain to be exercised


Disclosure requirementsMost of the disclosure requirements equal all leases under the Standard with financial contracts

◦ In the cashflow statement, the principal part of lease payments, and interest part, are respectively shown as financing activities

◦ Maturity analysis of lease liabilities as per IndAS 107

Lessee shall separately disclose leases of short tenure, and low value items


Treatment in case of sub-leasesA lessee who has acquired the asset on lease will recognise RoU asset and OTP liability as applicable to any other lessee

Simultaneously, as the lessee subleases the asset, the same will be treated as financial or operating lease based on its characteristics

Therefore, if the sublease is an operating lease:◦ The debit to P/L will be depreciation of RoU asset plus interest inherent in OTP liability

◦ The credit will be the lease rentals in entirety

◦ There is no impact on the ROU asset.

If the sub-lease is a financial lease◦ The debit to P/L will be depreciation of RoU asset plus interest inherent in OTP liability

◦ Credit will be the interest portion in the financial lease

◦ The RoU asset will be de-recognised and will be replaced by the net investment in the lease◦ Resulting gain/loss may be booked


Some nuances in Indian context – mismatch with taxation laws

•Will the accounting for the lease by the lessee affect Income-tax treatment:

• For Income-tax purposes, rentals are expensed in case of operating lease.

• Accounting treatment per se does not affect tax treatment

• When AS 19 on lease accounting was implemented, similar question arose. CBDT clarified that the tax treatment will not be affected by the accounting treatment.

• There is nothing to suggest that the tax deductibility of lease rentals by the lessee will be affected by the accounting standard

•Will the accounting affect GST treatment

• The concept of taxable supply under the GST laws is not dependent on accounting treatment

• As it is, GST did not distinguish between a financial lease and an operating lease

• Hence, there will be no impact on GST treatment as well


Meaning of financial debt under Insolvency lawThe definition of “financial debt” under the Insolvency and Bankruptcy Code refers to treatment as a financial lease as per applicable accounting standards

It is clear from a reading of the definition that the same refers to accounting treatment in the books of the lessee

Hence the definition of “financial debt” under the IBC gets disconnected with the accounting standards

◦ May be a subsequent amendment of the IBC may take care of the gap

◦ In the meantime, a lease qualify as a financial lease under IBC only on the point of substance over form


Impact on RBI regulationsRBI regulations as applicable to NBFCs are applicable in case of financial leases; not applicable in case of operating leases

The regulations are applicable from a lessor perspective

Since there is no change in financial lease/operating lease distinction from lessor viewpoint, the change of the accounting standard will have no impact from the viewpoint of RBI regulations.


Overall impact of Ind AS 116

Some unique points to Indian leasing◦ Very high proportion of operating leases to total leasing volume

◦ Presence of low-to-no equity investors who originate “operating leases” to sell receivables◦ Purported residual value play


Separating lease and non-lease component

Why?

A contract may have several components to it.

Example – a contract relating to use and maintenance of a car. There are two components here: a) use of car – lease component; and b) maintenance of car –non lease component.

Para 12 of Ind AS 116 requires accounting for lease component separately in the books of accounts by the lessor and lessee.


Separate lease component

Right to use an asset is a separate component only if both the conditions satisfy:

The lessee can benefit from the use of the asset either on its own or together with other resources that are readily available to the lessee

The underlying asset is neither high dependent on, nor highly interrelated with, the other underlying assets in the contract.

Separating lease and non-lease component (contd..)


A Ltd is a car manufacturer, it leases a car out to B Ltd. along with a maintenance contract for a period of 4 years. Annual payments to be made by B Ltd. is Rs. 1,60,000 which includes charges for both, use of asset and maintenance of asset.

The observable inputs available relating to the transaction are:

a. Observable price of maintenance contract for 4 years = Rs. 16000 p.a.

B. Observable price of lease of the car for 4 years = Rs. 1,44,000 p.a.

The fixed consideration to be paid by the lessee to the lessor may be allocated in the following manner:

Amount (Rs.)

Use of car – Lease component 576,000

Maintenance of car – Non lease component 16,000

640,000

Documents

Accounting for Leasing Transactions: IndAS 116 and IFRS 9