Changes in LEASE ACCOUNTING - Finance Ppl

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Changes in LEASE ACCOUNTING

Accounting in Lessee’s books

Before 2019 Companies followed Ind AS 17, which required lessees to classify leases as either operating leases (kept off the balance sheet & expensed as rent) or finance leases (on-balance sheet- capitalized).

From 2019 onwards, Ind AS 116 replaced Ind AS 17. It introduced a single lessee accounting model. The distinction between operating and finance leases has been eliminated and accounting Shall be as per the new model, which is explained as below:

  1. All leases longer than 12 months (unless the asset is of low value, like a laptop or printer) must be recognized on the balance sheet.
  2. Right-of-use asset (ROU): The lessee records the lease in the balance sheet as “ROU Asset”, classified under PPE, which represents the right to use the warehouses over the lease term.
  3. Liability Recognition: Lease Liability is recognized and disclosed in balance sheet measured at present value of future lease payments. Repayment of principal directly reduces the Lease Liability. After each payment, accountant shall re-calculate and shift the next 12 months of principal from "Non-Current" to "Current Liability.
  4. Expense recognition: Instead of rent expense, now there is depreciation on the ROU asset and Interest expense on the lease liability.
Accounting in Lessor's books

As Far as Lessor’s book is concerned, they shall continue with the dual model, which is

  1. Finance lease: Transfer substantially all risks/rewards, derecognize the Asset from books and recognize the lease receivable at an amount equal to net investment in lease. Lease payments received are split into two parts: reduction of the principal receivable and finance income (interest).
  2. Operating lease: Record and recognise the asset in books and depreciate it. Initial direct costs are often added to the carrying amount of the asset and recognized over the lease term. Recognize rental income in P&L
Step-by-Step Calculations:

To understand how Ind AS 116 works in practice, let us break its accounting into a clear sequence of calculations. This step-by-step approach shows how the present value of lease payments is calculated, how the ROU asset is recorded & how expenses are recorded in FS.

    Lessee’s Books - Calculation Flow

    As already mentioned, Under Ind AS 116 there is no difference in treatment between finance lease and operating lease. Regardless of type of lease, accounting is same. So, the present value calculation is mandatory for lessees in all leases.

  1. Lease liability

    2. Lease Liability calculation at Initial Measurement is as follows:
    1. Calculate PV of future lease payments.
    2. Discount using either: Built in rate (rate implicit in lease or borrowing cost.
    3. Lease Liability= Lease Liability = Σ [ Lease Payment / (1 + r)^t ]

  2. Right-of-Use (ROU) Asset

    Initial Measurement of Right-of-Use (ROU) Asset is at:
    Value that is equal to the lease liability, adjusted for the Initial direct costs, Lease incentives received, Prepaid lease payments.

    ROU Asset= Lease Liability+Initial Direct Costs-Incentives+Prepayments

  3. Subsequent measurement

    4. At year-end, the lease liability and ROU Asset are carried at:
    1. Lease Liability: Opening value of lease liability is increased by interest expense and is reduced by repayments.
    2. ROU Asset: ROU Asset is depreciated over lease term (straight-line unless another method better reflects usage).
    3. P&L Impact: Interest expense (finance cost) Depreciation expense (operating cost)