Indian Accounting Standard (Ind AS) 17 – Leases Exposure Draft on Leases – IndAS 116 By Veena Hingarh

Scope of this Standard This Standard shall be applied in accounting for all leases other than: leases to explore for or use minerals, oil, natural gas and similar nonregenerative resources; and licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights.

Scope of this Standard This Standard shall not be applied as the basis of measurement for: (a) property held by lessees that is accounted for as investment property (Ind AS 40) (b) investment property provided by lessors under operating leases (Ind AS 40) (c) biological assets within the scope of Ind AS 41 Agriculture

Understanding Core Terms Lease (Ind AS 17) An agreement whereby the lessor conveys to the lessee in return for payment the right to use an asset for an agreed period of time.

Understanding Core Terms Lease under Ind AS 116 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.

Determining whether an arrangement contains a lease When does a lease exist? Fulfilment of the arrangement is dependent on the use of a specific asset The arrangement conveys the right to use the asset

Determining whether an arrangement contains a lease Use of specific asset A specific asset is identified either explicitly or implicitly in an arrangement. It is not economically feasible or practical for the supplier to use alternative assets The supplier only owns one suitable asset for the performance of the obligation The asset used needs to be at a particular location or is specialised The supplier is a special purpose entity formed for a limited purpose

Determining whether an arrangement contains a lease Right to use the specific asset Identify right to use more than actual use Purchaser has ability (right) to operate or direct others to operate, obtaining control over more than an insignificant amount of output of asset. Purchaser has ability (right) to control physical access to the asset Purchase price is not a fixed market price per unit of output, and it is remote that any third party will take more than an insignificant part of output of the asset.

Determining whether an arrangement contains a lease Reassessment if arrangement contains a lease after inception: A change is made to the contractual terms, other than renewals and extensions A renewal option is exercised or an extension is agreed that was not in initial arrangement. A change is determined on whether fulfilment is dependent on a specified asset There is a substantial change to the asset.

Identifying a Lease Ind AS 116 When does a contract contain a lease A contract is, or contains a lease if it meets Fulfilment of the lease depends on the use of an identified asset The contract conveys the right to control for a period of time in exchange for consideration. Control The right to direct the use of the identified asset The right to obtain substantially all of the economic benefits

IndAS 17: Accounting for Lease Cash flows under arrangement must be separated into component Right to use the asset, Service and maintenance agreements, Right to use - lease under IndAS 17. Operating Lease Financial Lease

Classification of Leases Finance lease if it transfers substantially all the risks and rewards incidental to ownership. Operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.

Classification of Leases Risks include the possibilities of losses From idle capacity or Technological obsolescence, and of Variations in return because of changing economic conditions (including changes in the value of any residual interest). Rewards represented by Expectation of profitable operation over the asset’s economic life Gain from appreciation in value of any residual interest.

Classification of Leases Finance Lease the lease transfers ownership of the asset to the lessee by the end of the lease term. the lessee has the option to purchase the 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 inception of the lease, that the option will be exercised.

Classification of Leases Finance Lease the lease term is for the major part of the economic life of the asset even if title is not transferred. at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset. the leased assets are of such a specialised nature that only the lessee can use them without major modifications.

Classification of Leases Inception of the lease is the earlier of the date of the lease agreement and the date of commitment by the parties to the principal provisions of the lease.

Classification of Leases Under IndAs 116 A ‘right-of-use’ model replaces the ‘risks and rewards’ model. Lessees are required to recognise an asset and liability at the inception of a lease.

Classification of Leases ‘Substantially all’ Finance lease classification is not appropriate in cases where the lessor retains significant risks and rewards of ownership. In many cases the same classification (finance lease or operating lease) is appropriate for both the lessee and the lessor. However, in some cases different classifications are appropriate.

Classification of Leases Multiple parties to a lease classification: ‘Tripartite lease agreement whereby the lessor (entity A) transfers substantially all the risks and rewards of ownership to two unrelated parties—the lessee (entity B) obtains the right of use of the leased asset for a specified period and the other party (entity C) contracts to acquire the leased asset from the lessor (entity A) at the end of the lease term at a fixed price. How do A, B, and C Classify the lease In this case, the lessor (entity A) and the lessee (entity B) would classify the lease as a finance lease and an operating lease respectively. The third party (entity C) has a firm commitment to acquire the leased asset at the end of the lease term.

Classification of Leases Other situations of finance lease are: (a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee. (b) gains or losses from the fluctuation in the residual value of the leased asset accrue to the lessee (c) the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.

IndAS 17: Accounting for Financial Lease Lessee Lessor Balance sheet Leased asset (include indirect costs) Liability (PV of minimum lease payments) Receivable (less indirect costs) (PV of net investment) Income statement Depreciation Finance expense Profit on sale? Finance income

IndAS 17: Accounting for Operating Lease Lessee Lessor Balance sheet Lease rental payable Leased asset Lease rental receivable Income statement Lease rental expense Depreciation Lease rental income

Sale and Leaseback Transactions A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset. The lease payment and the sale price are usually interdependent because they are negotiated as a package. The accounting treatment of a sale and leaseback transaction depends on the type of lease.

Sale and Leaseback Transactions Finance lease any excess of sales proceeds over the carrying amount in the books of the lessee (vendor) should be deferred and amortised over the lease term.

Sale and Leaseback Transactions Operating lease Defer and amortise excess over fair value Defer and amortise loss Sale price = FV Recognise profit or loss immediately Sale price > FV Sale price < FV and, in case of a loss, not compensated by future below-market lease payments Sale price < FV and resulting loss is compensated by future below-market lease payments

Operating Lease Incentives Recognised as an integral part of the net consideration Lessor - aggregate cost of incentives a reduction of rental income over the lease term, On a straight-line basis unless another systematic basis is representative of the time pattern over which the benefit of the leased asset is diminished. Examples of such incentives are an up-front cash payment to the lessee or the reimbursement or assumption by the lessor of costs of the lessee (such as relocation costs, leasehold improvements and costs associated with a pre-existing lease commitment of the lessee). Alternatively, initial periods of the lease term may be agreed to be rent-free or at a reduced rent.

Operating Lease Incentives Recognised as an integral part of the net consideration Lessee - aggregate benefit of incentives as a reduction of rental expense over the lease term, On a straight-line basis unless another systematic basis is representative of the time pattern of the lessee’s benefit from the use of the leased asset. Examples of such incentives are an up-front cash payment to the lessee or the reimbursement or assumption by the lessor of costs of the lessee (such as relocation costs, leasehold improvements and costs associated with a pre-existing lease commitment of the lessee). Alternatively, initial periods of the lease term may be agreed to be rent-free or at a reduced rent. 2 The issue is how incentives in an operating lease should be recognised in the

IndAS 116: Lease Effective January 1, 2019 Lease is a contract that conveys the right to use an asset for a period of time in exchange for consideration Identified asset (explicitly or implicitly) A right to control the use of the asset for a particular period Control – ability to direct and derive benefit from use

IndAS 116: Lease The distinction between operating and finance leases is eliminated for lessees Lease asset (representing the right to use the leased item for the lease term) Lease liability (representing the obligation to pay rentals)

IndAS 116: Lease Lessee Accounting Right-of-use model A lessee would recognise a right-of-use asset and a lease liability for all leases of more than 12 months. Asset and the liability are initially measured at the present value of lease payments. The right-of-use asset also includes any costs incurred that are directly related to entering into the lease. Short-term leases - Option to exclude leases less than 12 months Variable lease payments – exclude if linked to sale or use, include if linked to index or a rate Optional payments – exclude unless significant incentive to exercise option

IndAS 116: Lease Lessee Accounting Consumption principal Two kinds of leases A lease for which the lessee pays for the part of the underlying asset that it consumes (or uses up) during the lease term Equipment, vehicles, and other depreciating assets Lessor prices lease to recover value of the part of the asset consumed and return on its investment in asset.

IndAS 116: Lease Dual approach - Consumption principal Type 1: Type 2: A lease for which the lessee merely pays for use Land, building and other property the lessor prices the lease to obtain a return on its investment in the underlying asset Income Statement Cash Flow Statement Type 1: Type 2: Amortisation, depreciation, Interest Principal paid Interest Single Lease Expense Total cash paid

IndAS 116: Lease Lessor Accounting - Does not change Continue to reflect the underlying asset subject to the lease arrangement on the balance sheet for leases classified as operating. For financing arrangements or sales, the balance sheet reflects a lease receivable and the lessor’s residual interest, if any