Transitioning to new leasing standard - Ind AS 116 - Are you ready? May 2019 - EY
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Transitioning
to new leasing
standard –
Ind AS 116
Are you ready?
May 2019
1 Transitioning to new leasing standard – Ind AS 116
We acknowledge contributions from:
Sandip Khetan Jigar Parikh,
National Leader and Partner Partner
Financial Accounting Financial Accounting
Advisory Services (FAAS), EY India Advisory Services (FAAS), EY India
sandip.khetan@in.ey.com jigar.parikh@in.ey.com
Varun Dewan Tarushi Garg
Director Manager
Financial Accounting Financial Accounting
Advisory Services (FAAS), EY India Advisory Services (FAAS), EY India
varun.dewan@in.ey.com tarushi.garg@in.ey.com
India Inc. made a mammoth journey in transitioning to the International Financial Reporting Standards (IFRS) convergent Ind AS standards in a phased manner over 2016 and 2017. This was followed by new standard on Revenue recognition, which became applicable with effect from 1 April 2018. Business complexities are increasing and this is forcing the regulators globally to issue new accounting guidance, to help businesses reflect most appropriate financial position of a company. The trend of issuing new literature is expected to continue in the future as well and for the corporates to successfully navigate the changes, meticulous planning coupled with investment in acquiring accounting knowledge would be of prime importance. The Ministry of Corporate Affairs (MCA) notified Ind AS 116 on 30 March 2019, which replaces the existing standard (Ind AS 17) from accounting periods beginning 1 April 2019 and after. The Institute of Chartered Accountants of India (ICAI) had previously issued the exposure draft for Ind AS 116 on 20 July 2017. The notified standard is similar to the exposure draft issued by ICAI. The new standard overhauls the accounting for lessees by completely letting go off the previous “dual” finance vs. operating lease model and does not allow Indian corporates to shy away from finance lease accounting anymore. The guidance in the new standard requires lessees to adopt a single model approach which brings leases on the balance sheet on day 1, in the form of a right-of-use asset and a lease liability. Additionally, from a lessor standpoint, the carve out as prescribed under Ind AS 17, in relation to straight lining of lease rental has been done away with and will require lessors to evaluate and apply the same on a prospective basis. Ind AS 116 will affect commonly used financial ratios and performance metrics such as the gearing ratio, current ratio, asset turnover ratio, interest coverage ratio, earnings before interest, tax and depreciation (EBITDA), operating profit, net income, earning per share (EPS), return on capital employed (ROCE), return on equity (ROE) and operating cash flows. Unless the lending terms define the computation of the financial metrics independent of GAAP requirements, Ind AS 116 is more likely to have an impact on the existing debt covenants as well. Cost of borrowings are based on the credit rating of companies and the general health of the financial statements. Credit rating agencies in India consider the impact of off- balance sheet liabilities when arriving at their ratings. As such, for companies where credit ratings are available, the cost of borrowings is not expected to change significantly. However, for the smaller borrowers, application of Ind AS 116 will bring greater transparency to their financial statements, thereby having an impact on their cost of borrowings. The complexity of applying the new right of use model (ROU) along with the potential impact on cost of borrowings may lead more companies to reassess the lease or buy decisions. In this report we discuss the potential impact of the new lease standard on the sample set of the top 100 BSE companies along with a sector-wise dissection. Considering the impact and complexities of the new leasing standard, it is expected that accounting teams would have to be well prepared to navigate the change. We hope you find our insights and perspectives useful.
Adopting the new lease
accounting standard will require
companies to have proper controls
and develop the accounting and
reporting framework for applying
the new standard
Sandip Khetan
National Leader, Financial
Accounting Advisory
Services, EY India
Sector-wise potential impact
Airlines sector
Most airline companies finance aircrafts through off-balance sheet lease
models, as a common practice in the aviation industry. In addition, other assets
such as check-in kiosks, boarding gates, which are taken on lease from Significant
respective airport owners are also classified as operating leases.
Another key change for this sector will be the treatment of sale and leaseback
transactions, wherein determining whether a sale has occurred in the context of
impact on
a sale and leaseback transaction is already a judgmental area under the new multiple sectors
revenue recognition standard (Ind AS 115).
The changes under Ind AS 116 will bring all these arrangements on the balance
sheet of airline companies, having a significant increase in lease assets and
liabilities on day 1.
Transport and logistics sector
Wet lease
Arrangements in the transportation and logistics sector usually contain
arrangements to multiple components typically termed as a "wet leases“. For example, the
be allocated in lease of a ship would include the lease payments for the ship, the crew and
maintenance services which are currently classified as one lease
lease and non-lease arrangement and charged as “operating lease expense”. Under the new
components guidance, arrangements are required to be allocated between lease and non-
lease components. Segregation of arrangement may have significant impact
on accounting under new guidance, depending upon the value of lease and
non-lease components.
Retail and consumer sector
Most rental contracts for retail outlets whether for individual
outlets or high street stores are likely to qualify as leases, as such
contracts will meet the key criteria for lease, which is having the
right to control the asset and obtaining the related economic
benefits from the use. Under the retail sector, leases with variable
payments, for example where lease payments that are dependent
Key impact on: Initial
on the consumer price index or rate, will need to be assessed as the
lease liabilities associated with variable payments are required to be direct costs and
re-measured at each date of change of the future contractual cash
flows. This recurring re-measurement will introduce volatility in the
balance sheet.
arrangements
Another impact area will be the treatment of initial direct costs,
such as commissions, as some costs might need to be included as
with non-lease
part of the right of use asset and amortized over the anticipated
lease term. A third significant impact on the retail and consumer
components
sector will be the arrangements with non-lease components such as
property management, maintenance, security distribution and
power services which in some cases may have been clubbed
together as “operating lease” expense.
5 Transitioning to new leasing standard – Ind AS 116
Sector-wise potential impact (cont’d.)
Information technology sector
Leasing has long been an attractive option in IT and IT enabled
Arrangements for
services sector. Real estate leases are common in IT sector for
setting up development and delivery centres, along with leases of IT
co-location
hosting and cloud
equipment and services. The arrangements for "co-location" hosting
and even some "cloud" services usually contain multiple elements of
hardware support along with personnel assistance. Under the new
standard, these will now need to be evaluated and accordingly
allocated.
services need to
be evaluated
Power and utilities
In the power sector, “pole attach” agreements whereby a utility
Re-assess agreements allows a third party to attach equipment, such as a telephone or
for substitution
cable, to its utility pole for a monthly fee, are a common
occurrence. Such agreements will have to be assessed for
“substitution fee”. In case they can be substituted and the supplier
rights and lease- would economically benefit from such substitution, the right to use
the underlying asset may have to be considered non-substantive.
non-lease In addition, power purchase agreements (PPA) will also need to be
evaluated for substitution rights and lease and non-lease
components components, if they are not classified as “service concession
agreements” under Ind AS 115, “Revenue from contracts with
customers”. The new lease standard requires the assessment of
whether a contract gives the customer the right to control the use
of a specified asset. If not, the PPA would have to be segregated
into lease and non-lease components and accounted for
accordingly.
Telecom
Contracts involving direct cable that is a part of a larger infrastructure
(such as unbundled network element arrangements for the “last mile” to Consider impact on
a customer location, “special access” arrangements for a dedicated
connection between two locations) may fall in the definition of an unbundled
identified asset and will therefore be required to be accounted for on-
balance sheet. network
arrangements
Another key feature of the telecom sector are the mobile tower-sharing
arrangements. Such arrangements between operators will need to be
assessed for lease and non-lease components and accordingly be
accounted for on-balance sheet.
Healthcare and pharmaceutical sector
Hospitals enter into arrangements for leasing medical device equipment, many of which are currently accounted for as
operating leases. These assets, if falling under the definition of an identified asset, will have to be accounted for on-balance
sheet.
Transitioning to new leasing standard – Ind AS 116 6
Sector-wise potential impact (cont’d.)
Engineering and construction
The new lease standard will require engineering and construction companies Separation of
construction
to recognize construction equipment and office space, currently accounted
for as operating leases, as on-balance sheet leases. Further, wherever these
arrangements contain substitution rights, these will need to be analyzed to
determine whether the supplier would economically benefit from exercising and service
these rights, in order to be considered substantive.
components
Additionally, components of arrangements such as maintenance service for
construction equipment or service contracts will have to be bifurcated for
lease and non-lease components for separate treatment of both.
Mining and minerals
Key impact on leases Most of the equipment used in exploration and evaluation (E&E)
taken for and other mining activities which are currently accounted for as
operating leases will have to be evaluated under the new standard.
exploration Additionally, mining services arrangements containing drilling and
blasting services, smelting and transportation services will have to
and evaluation be bifurcated into lease and non-lease components for separate
treatment of both.
Oil and gas
The assessment of whether there is an identified asset in companies in
the oil and gas sector, will be straightforward in most arrangements,
but judgment will be required in certain arrangements. A physically
distinct portion of a larger asset (e.g., segment of a pipeline that
connects a single customer to a larger pipeline) can be an identified Consider impact on
asset.
Further assessing the lease and non-lease components in processing,
transportation and storage contracts, outsourced oil and gas service
unbundled
contracts and drilling contracts, which typically include operation
services, etc. will be an additional point of judgement.
network
In addition, because the current accounting for operating leases and
service contracts is similar, entities may not have always focused on
arrangements
determining whether an arrangement is a lease or a service contract.
Depending on the significance of these arrangements, the new
standard will impact the financial statements and the key financial
metrics used to report results.
7 Transitioning to new leasing standard – Ind AS 116
The new standard on lease
accounting is amongst one of the
biggest accounting changes in
recent times – not only for the
Indian market but globally.
Companies need to evaluate the
impact carefully
Jigar Parikh
Partner, Financial
Accounting Advisory
Services, EY India
Impact of the standard
Overview
We have reviewed the lease disclosures per Ind AS 17 made by some of the largest companies in India to
help understand the current lease landscape in the country. The objective of this analysis is to try and
paint a picture of how the future financial statements may look post application of Ind AS 116 to such
companies. Our analysis has been presented in detail in subsequent sections. Given below is the summary
of key findings:
► Lessees will have a single accounting model for all leases, with two
exemptions (low value assets and short term leases)
► Lessor accounting is substantially unchanged
► There will be additional disclosure
requirements
Balance sheet
► Companies with operating leases will
appear to be more asset-rich, but also
Yr 1 Yr 2 Yr 3 Yr 4
more heavily indebted
Airlines
Telecom
Asset Liability
Retail
Statement of profit and loss
► Total lease expense will be front-loaded Key impact of the new
even when cash rentals are constant standard
Depreciation Interest
Cash rental payments
Disclosures
► Companies, both lessors and lessees, to
review current disclosures and also
prepare for enhanced disclosure
requirements
Favorable impact expected Adverse impact expected
► EBITDA ► Net assets
► Total assets ► Interest coverage ratios
9 Transitioning to new leasing standard – Ind AS 116
Evolution of leasing in India
Lease accounting has undergone significant changes over the years. In India, before the advent of Ind AS, the lease standard
under IGAAP (Accounting Standard 19 on Leases) was based on an older pre-1997 version of IAS 17. This standard was
applicable for all leases entered on or after 1 April 2001. For the first time in India this standard introduced dual classification
model of operating and finance leases. This model differentiates between classification and measurement of operating leases
and finance leases.
IAS 17 was brought in the Indian accounting scenario by way of Ind AS 17 which was fully converged to IAS 17. However, in
this model, users of financial statements are unable to assess the nature and extent to which an enterprise is exposed on
account of leasing commitments as the operating leases are not reflected on the entity’s balance sheet.
The dual classification model fails to account for the assets and liabilities associated with the rights and obligations that arise
out of most ”operating” leases.
Globally, the call to bring lessee accounting on a single lease classification model was first proposed in 1996. Between 2009
and 2016, IASB issued various discussion papers, held multiple corporate discussions, meetings and revisions. It was then in
January 2016 that IASB issued IFRS 16, the standard which replaces the existing IAS 17. IFRS 16 will be effective globally for
financial periods beginning on or after 1 January 2019.
In India, Ind AS 116 has been notified on 30 March 2019 and is effective from financial periods beginning on or after
April 2019.
1983 1985 1995
First draft AS on leases New exposure draft was RBI forced leasing
in India, same as then prepared by the companies to accept ICAI’s
applicable IAS 17 Research Committee guidelines of leasing
2017 2016 2001
Exposure Draft on Lease Ind AS 17 effective for Accounting standard 19
Accounting phase 1 entities on leases applicable,
transitioning to Ind AS akin to pre-1997 IAS 17
The new standard shall require lessees to recognize
2019 ►
most leases on their balance sheets. Lessees will use
a single accounting model for all leases, with limited
Notified on 30 March 2019 exemptions
and effective from
1 April 2019 ► Lessor accounting is substantially unchanged
Transitioning to new leasing standard – Ind AS 116 10What is changing?
Effective from annual periods beginning on or after 1 April 2019, Ind AS 116 supersedes the existing Ind AS 17. The new
standard requires entities to make more judgements and estimates (e.g., determining when a customer has the right to direct
the use of an identified asset, estimating the incremental rate of borrowing) and make more disclosures (e.g., discount rate,
weighted average lease term, other qualitative and quantitative information). In the capacity of a lessee, most companies will
have a significant impact on their balance sheets along with ancillary impacts on their financial metrics.
► IFRS 16 will be effective for annual periods beginning on or after 1 January 2019. Early
application is permitted, provided the new revenue standard, IFRS 15 Revenue from
Contracts with Customers, has already been applied or is applied at the same date as the
new lease standard.
► Wide Notification from MCA dated 30 March 2019, Ind AS 116 (corresponding to IFRS 16)
has been made effective for accounting periods beginning on or after 1 April 2019.
11 Transitioning to new leasing standard – Ind AS 116About Ind AS 116 Key principle Ind AS 116 requires lessees to recognize most leases on their balance sheets. The new standard is a significant change in approach from current Ind AS and will affect many entities across various industries. Scope Lease transactions for all assets are covered under Ind AS 116, except: ► Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources ► Leases of biological assets ► Service concession arrangements ► Licences of intellectual property granted by lessor ► Rights held by a lessee under certain licensing agreements (e.g. films) Lessee accounting Lessees are required to initially recognize a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The lease liability is measured at the present value of the lease payments to be made over the lease term. The right-of-use asset is initially measured at the amount of the lease liability, adjusted for lease prepayments, lease incentives received, the lessee’s initial direct costs (e.g., commissions) and an estimate of restoration, removal and dismantling costs. Lessees accrete the lease liability to reflect interest and reduce the liability to reflect lease payments made. The related right- of-use asset is depreciated in accordance with the depreciation requirements of Ind AS 16 Property, Plant and Equipment. For lessees that depreciate the right-of-use asset on a straight-line basis, the aggregate of interest expense on the lease liability and depreciation of the right-of-use asset generally results in higher total periodic expense in the earlier periods of a lease. Lessees re-measure the lease liability upon the occurrence of certain events (e.g., change in the lease term, change in variable rents based on an index or rate), which is generally recognized as an adjustment to the right-of-use asset. Refer Appendix 2 for key lessee disclosures. Lessor accounting Lessors classify all leases using the same classification principle as in Ind AS 17 and distinguish between two types of leases- operating and finance leases. For operating leases, lessors continue to recognize the underlying asset. Lessors recognize lease income on either a straight- line basis or another systematic basis that is more representative of the pattern in which benefit from the use of the underlying asset is diminished. Transitioning to new leasing standard – Ind AS 116 12
About Ind AS 116 (cont’d.)
For finance leases, lessors derecognize the underlying asset and recognize a net investment in the lease similar to
today’s requirements. Any selling profit or loss is recognized at lease commencement. Lessors recognize interest
income for the accretion of the net investment in the lease and reduce that investment for payments received.
Lessor accounting under the new standard is impacted by the changes in the definition of a lease, change in the
recognition and measurement criteria and other extensive disclosure requirements (refer Appendix 2), including
information about how they manage the risk related to residual values of assets under lease. However, the biggest
change to lessor accounting is on account of change in the recognition and measurement principle of operating leases
for lessors. Under the previous lease standard, companies were not required to straight-line rental income if payments
in relation to operating leases were structured to increase in line with expected general inflation. Accordingly, at the
time of first time adoption of Ind AS, several Indian companies had reversed the revenue equalization reserves in order
to comply with such criteria. The new lease standard does not require entities to compare the lease escalations during
the life of a lease to the inflation percentage in the economy and therefore Indian companies will have to assess and
recognize equalization reserves once again in their books of accounts on a prospective basis for the remaining period of
the operating lease.
Other considerations : Identifying and separating lease
components of a contract
For the contracts that contain the rights to use multiple assets (e.g., a building and equipment, multiple pieces of
equipment) the right to use each asset is considered a separate lease component. The non-lease components are
identified and accounted for separately from the lease components.
Right to use each asset is considered a separate lease component if both:
► 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 highly dependent on, nor highly interrelated with, the other underlying assets in the
contract
Some contracts contain items that do not relate to the transfer of goods or services by the lessor to the lessee (e.g.,
fees or other administrative costs a lessor charges a lessee). These items are not considered separate lease or non-
lease components, and lessees and lessors do not allocate consideration in the contract to these items. However, if the
lessor provides services (e.g., maintenance, supply of utilities) or operates the underlying asset (e.g., vessel charter,
aircraft wet lease), the contract would generally contain non-lease components.
Identifying non-lease components of contracts (e.g., maintenance services provided with a
mobile tower arrangement that is treated as a lease) may change practice for some lessees.
Today, lessees may not focus on identifying lease and non-lease components because their
accounting treatment (e.g., the accounting for an operating lease and a service contract) is
often the same. However, because most leases are recognized on lessees’ balance sheets
under Ind AS 116, lessees may need to put more robust processes in place to identify the lease
and non-lease components of contracts.
13 Transitioning to new leasing standard – Ind AS 116About Ind AS 116 (cont’d.)
Accounting of embedded leases
While current leasing guidance requires that embedded leases be identified and accounted for separately, most lessees were
not always diligent in doing so because typically, they were off-balance-sheet. However under the new guidance, balance
sheet amounts will be misstated if embedded leases are not identified and accounted for appropriately.
There is judgment involved in assessing if an arrangement contains an embedded lease. The general rule under the new model
is that an arrangement contains a lease if (1) there is an explicit or implicit identified asset in the contract, and (2) the
customer controls use of the identified asset.
While an asset may be explicitly or implicitly specified in the contract, a lessee would not have control over the use of the asset
if the lessor has a substantive right to substitute the asset throughout the period of use. Substitution right can said to be
substantive if the lessor has the practical ability to substitute the asset, and the lessor would benefit economically from
exercising its right to substitute the asset.
A contract conveys the right to control the use of an identified asset for a period of time if, throughout the period of use, the
customer has both of the following:
► The right to obtain substantially all of the economic benefits from the use of the identified asset
► The right to direct the use of the identified asset
The new standard will have a significant impact on multiple sectors, in particular how they identify embedded leases, allocate
contract consideration to components, and the impact of reflecting leases on a lessee’s balance sheet.
Example 1: Fiber optic cable
Customer enters into a 15-year contract with a utilities company (Supplier) for the right to use
three specified, physically distinct dark fibers within a larger cable connecting location A to
location B. Customer makes the decisions about the use of the fibers by connecting each end of
the fibers to its electronic equipment (i.e., customer lights, the fibers and decides what data and
how much data, those fibers will transport). If the fibers are damaged, Supplier is responsible for
the repairs and maintenance. Supplier owns extra fibers, but can substitute those for Customer’s
fibers only for reasons of repairs, maintenance or malfunction (and is obliged to substitute the
fibers in these cases).
Based on the fact in this example, the contract contains a lease of dark fibers. Customer has the
right to use the three dark fibers for 15 years.
The three identified fibers are explicitly specified in the contract and are physically distinct from
other fibers within the cable. Supplier cannot substitute the fibers other than for reasons of
repairs, maintenance or malfunction.
Transitioning to new leasing standard – Ind AS 116 14About Ind AS 116 (cont’d.)
Customer has the right to control the use of the fibers throughout the 15-year period of use
because:
a) Customer has the right to obtain substantially all of the economic benefits from use of the
fibers over the 15-year period of use. Customer has exclusive use of the fibers throughout the
period of use
b) Customer has the right to direct the use of the fiber as the customer makes the relevant
decisions about how and for what purpose the fibers are used by deciding: (i) when and
whether to light the fibers and (ii) when and how much output the fibers will produce (i.e.,
what data and how much data, those fibers will transport). Customer has the right to change
these decisions during the 15-year period of use
15 Transitioning to new leasing standard – Ind AS 116Practical expedients
and accounting policies choices
The new standard provides lessors and lessees with various accounting policy choices
and practical expedients which can be applied during transition:
For leases with a lease
Entities are term of 12 months or less,
permitted to make an election lessees have an accounting
whether to reassess contracts A lessee policy election to not
to identify contracts may elect, by class of underlying recognize lease assets or
containing a lease or apply asset, not to separate non-lease liabilities, by class of
practical expedient such that components from lease underlying asset. For leases
contracts that do not contain components and instead account with underlying asset of low
a lease under Ind AS 17 are for both as a single lease value, lessees have an
not required component accounting policy election
to be reassessed to not recognize lease
assets or liabilities, on a
lease-by-lease basis
The standard
may be applied to a portfolio
of leases with similar
A lessee has the option to, but characteristics, provided that
is not required to, apply the it is reasonably expected that
standard to leases of the effects will not
intangible assets differ materially from
applying the Standard
to the individual leases within
that portfolio
The guidance provides for
Entities need to carefully certain practical expedients
evaluate and select the which are available to the
transition provision which they companies. Careful selection
deem most appropriate of the expedients is required
to be made
Transitioning to new leasing standard – Ind AS 116 16About Ind AS 116 (cont’d.)
An illustration: Lessees – Extract of financials at end of year one
Profit (year 1) Ind AS 17 Ind AS 116 Impact
Lease rental expense (1,000,000) - 1,000,000
EBITDA (1,000,000) - 1,000,000
Amortization charge - (479,391) (479,391)
EBIT (1,000,000) (479,391) 520,609
Finance costs - (790,996) (790,996)
(Loss) before tax (1,000,000) (1,270,387) (270,387)
Balance sheet Ind AS 17 Ind AS 116 Impact
Assets - 6,711,478 6,711,478
Liabilities - 6,981,865 6,981,865
Equity - (270,387) (270,387)
Assumptions
► One lease ► 11% discount rate
► CU1,000,000 rental p.a. ► No contingent rentals
► No straight-lining required ► Initial asset and liability CU7.2m
► 15 year term
17 Transitioning to new leasing standard – Ind AS 116Transition Based on the accounting options provided under Ind AS 116, entities have three different accounting approaches at the time of transition. We have presented the impact of each approach on the balance sheet, statement of profit and loss and the statement of changes in equity in each of the three approaches: Full retrospective approach: The transition impact based on the full retrospective transition approach will be as follows: • The lease liability is recognized on the lease commencement date using the interest rate implicit in the lease. If that rate cannot be readily determined, the incremental borrowing rate is used for discounting • Comparative periods are restated as if Ind AS 116 is applied from the commencement of the lease, as such entities will present a third balance sheet as at the beginning of the preceding period in addition to the minimum comparative financial statements • The provisions of Ind AS 8 “Accounting policies, changes in accounting estimates and errors” are applied. Accordingly, a third statement of financial position as at the beginning of the preceding period is presented, in addition to the minimum comparative financial statements Modified retrospective approach: The transition impact based on the modified retrospective transition approach will be as follows: • For the FY 2019-2020, the effective date of initial application will be 1 April 2019. • The lease liability is recognized at the date of initial application. The lease liability is measured at the present value of the remaining lease payments discounted using lease incremental borrowing rate at the date of initial application • Under the option given in para C8(b)(i), the right-of-use asset is recognized at the date of initial application. The ROU asset is measured as if the Standard had been applied since the commencement date, but discounted using incremental borrowing rate at the date of initial application. Difference between ROU asset and lease liability is recognized in the opening retained earnings on initial application • Under the option given in para C8(b)(ii), the right-of-use asset is recognized at the date of initial application . The ROU asset is measured at an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease recognized in the balance sheet immediately before the date of initial application Transitioning to new leasing standard – Ind AS 116 18
Transition
Full retrospective approach
Assumptions
► CU1,000,000 rental p.a., no escalation ► Discount rate on the date of lease inception - 8%
► 15 year term, four year period remaining on the date of
► No contingent rentals
transition
► Depreciation is under straight line method ► Date of transition is 1 April 2019
Extract of balance sheet - as may be reported at the end of Year 1 of transition
Particulars 31 March 2020 31 March 2019 1 April 2018^
Assets
Right of use asset 1,141,264 1,711,896 2,282,528
Total assets 1,141,264 1,711,896 2,282,528
Equity
Other equity (642,001) (865,201) (1,029,599)
Total equity (642,001) (865,201) (1,029,599)
Liability
Lease liability 1,783,265 2,577,097 3,312,127
Total liabilities 1,783,265 2,577,097 3,312,127
Total equity and liabilities 1,141,264 1,711,896 2,282,528
Impact on statement of profit and loss
Amortization and depreciation
(570,632) (570,632) -
expense
Finance cost (206,168) (264,970) -
Operating lease 1,000,000 1,000,000 -
Profit/ (loss) for the year 223,200 164,398 -
Extract of statement of changes in equity
Opening balance (865,201) (1,029,599) -
Profit/ (loss) for the year 223,200 164,398 -
Adjustment on transition
- - (1,029,599)
to Ind AS 116
Closing balance (642,001) (865,201) (1,029,599)
^ Balances as at 1 April 2018 are presented in accordance with the requirements of Ind AS 8
19 Transitioning to new leasing standard – Ind AS 116Transition
Modified retrospective approach –
para C8(b)(i)
Assumptions
► CU1,000,000 rental p.a., no escalation ► Discount rate on date of initial application - 11%
► 15 year term, four year period remaining on the date of
► No contingent rentals
transition
► Depreciation is under straight line method ► Date of transition is 1 April 2019
Extract of balance sheet – as may be reported at the end of Year 1 of transition
Particulars 31 March 2020 1 April 2019^ 31 March 2019*
Assets
Right of use asset 958,783 1,438,174 -
Total assets 958,783 1,438,174 -
Equity
Other equity (753,741) (1,005,541) -
Total equity (753,741) (1,005,541) -
Liability
Lease liability 1,712,524 2,443,715 -
Total liabilities 1,712,524 2,443,715 -
Total equity and liabilities 958,783 1,438,174 -
Impact on statement of profit and loss
Amortization and
(479,391) - -
depreciation expense
Finance cost (268,809) - -
Operating lease 1,000,000 - (1,000,000)
Profit/(loss) for the year 251,800 - (1,000,000)
Extract of statement of changes in equity
Opening balance (1,005,541) - -
Profit/ (loss) for the year 251,800 - (1,000,000)
Adjustment on transition
- (1,005,541) -
to Ind AS 116
Closing balance (753,741) (1,005,541) (1,000,000)
^ Balances as at 1 April 2019 for illustrative purposes only, not be presented in the financial statements
* Balances as at 31 March 2019 are same as those presented under Ind AS 17
Transitioning to new leasing standard – Ind AS 116 20Transition
Modified retrospective approach –
para C8(b)(ii)
Assumptions
► CU1,000,000 rental p.a., no escalation ► Discount rate on date of initial application - 11%
► 15 year term, four year period remaining on the date of
► No contingent rentals
transition
► Depreciation is under straight line method ► Date of transition is 1 April 2019
Extract of balance sheet – as may be reported at the end of Year 1 of transition
Particulars 31 March 2020 1 April 2019^ 31 March 2019*
Assets -
Right of use asset 1,629,142 2,443,715 -
Total assets 1,629,142 2,443,715 -
Equity
Other equity (83,381) - -
Total equity (83,381) - -
Liability
Lease liability 1,712,523 2,443,715 -
Total liabilities 1,712,523 2,443,715 -
Total equity and liabilities 1,629,142 2,443,715 -
Impact on statement of profit and loss
Amortization and
(814,572) - -
depreciation expense
Finance cost (268,809) - -
Operating lease 1,000,000 - (1,000,000)
Profit/(loss) for the year (83,381) - (1,000,000)
Extract of statement of changes in equity
Opening balance - - -
Profit/ (loss) for the year (83,831) - (1,000,000)
Adjustment on transition
- - -
to Ind AS 116
Closing balance (83,831) - (1,000,000)
^ Balances as at 1 April 2019 for illustrative purposes only, not be presented in the financial statements
* Balances as at 31 March 2019 are same as those presented under Ind AS 17
21 Transitioning to new leasing standard – Ind AS 116Impact of new standard in detail
Analysis of high market-cap
companies
To understand the likely impact of the new leasing standard, we have reviewed the annual reports
of the Top 100 companies listed on the Bombay Stock Exchange along with certain additional
sector specific entities. For details of entities in-scope of our analysis, along with a reconciliation of
all BSE top 100 companies and the companies covered for the purpose of our analysis, along with
a complete list of entities by sector, refer Appendix 4.
The objective was to gather understanding of current leasing landscape and lease obligations of
India’s largest corporates. We have also attempted to categorize the impacts across sectors.
In doing our analysis, we have looked at the current book values of future lease obligations and
have also tried to arrive at likely present value.
The anticipated amount of lease assets added to the balance sheet and the associated impacts on other financial statement
captions is computed based on the following assumptions:
► All amounts are presented in INR crores, unless otherwise stated.
► Financial information of the companies is based on the consolidated financial statements published for the year ended 31
March 2018. Refer to the list of entities covered in the analysis given under Appendix 4.
► Total future lease payments of each entity is discounted using a rate of 11%. The discount rate is assumed based on
average market interest rates in India and are similar to the average rates considered by entities for discounting during the
first-time adoption for Ind AS in India.
► Operating lease expenses for the 12 months immediately after the reporting date have been assumed to be the lease
expenses for one year.
► Average lease term of the outstanding leases is computed by dividing total future lease payments with the estimated
annual lease expenses.
► The present value of minimum lease payments is recognized as a right-of-use asset on day 1, with a corresponding
recognition of lease liability of the same value.
► Based on these assumptions, the anticipated impact on each financial statement caption on account of bringing the off-
balance sheet leases on the balance sheet is presented in the impact analysis section of this report.
► The increase in EBITDA is on account of reduction of operating lease expenses. These expenses now take the form of
depreciation and interest expense which improves EBITDA.
► The differential rate at which depreciation and interest expense are recorded in the statement of profit and loss leads to an
impact on profit and equity on a year-to-year basis. However, there is no impact on profit over the total lease term.
► Finance costs are accreted on the financial liabilities at the rate of 11%.
► Depreciation is computed on a straight-line basis over the lease term.
23 Transitioning to new leasing standard – Ind AS 116Impact on financial statements
INR crores
Percentage of present value of future payments to total assets as on 31 March 2018
Future
% of present
payments Present value
% of future value of
No. of for off of
Sectors Total assets payments to future
companies balance future
total assets payments to
sheet payments
total assets
leases
Airlines 02 34,084 20,113 59.01% 15,838 46.47%
Retail 03 19,576 7,544 38.54% 5,466 27.92%
Telecom 02 270,262 41,677 15.42% 29,806 11.03%
Technology (IT/IES) 06 346,272 12,424 3.59% 9,177 2.65%
Oil and gas 07 1,859,426 53,802 2.89% 37,827 2.03%
Media and
02 16,405 252 1.54% 215 1.31%
entertainment
Transportation and
04 13,857 228 1.65% 171 1.23%
logistics
Automobiles and
10 682,282 6,228 0.91% 4,418 0.65%
transportation
Mining and metals 08 948,787 5,521 0.58% 3,974 0.42%
Healthcare,
pharmaceutical and 10 287,683 1,418 0.49% 1,096 0.38%
chemicals
Consumer/
18 457,043 1,526 0.33% 1,154 0.25%
Industrial products
Real estate,
infrastructure, power 05 843,779 1,637 0.19% 1,009 0.12%
and utilities
Total 77 5,779,456 152,370 2.64% 110,151 1.91%
Big Impact sector Less Impact sector
► Airlines ► Real estate, infrastructure, power and
utilities
► Retail
► Consumer/ Industrial products
► Telecom
► Healthcare, pharmaceuticals and chemicals
Transitioning to new leasing standard – Ind AS 116 24Impact on financial statements
INR crores
Percentage of present value of future liability to total liability as on 31 March 2018
Future % of present
payments % of future Present value value of
No. of for off payments to of future
Sectors Total liabilities
companies balance total future payments to
sheet liabilities payments total
leases liabilities
Airlines 02 34,146 20,113 58.90% 15,838 46.38%
Retail 03 10,717 7,544 70.39% 5,466 51.00%
Telecom 02 174,949 41,677 23.82% 29,806 17.04%
Technology (IT/IES) 06 87,206 12,424 14.25% 9,177 10.52%
Oil and gas 07 1,111,146 53,802 4.84% 37,827 3.40%
Media and
02 4,137 252 6.09% 215 5.19%
entertainment
Transportation and
04 2,610 228 8.75% 171 6.55%
logistics
Automobiles and
10 418,407 6,228 1.49% 4,418 1.06%
transportation
Mining and metals 08 607,601 5,521 0.91% 3,974 0.65%
Healthcare,
pharmaceutical and 10 137,091 1,418 1.03% 1,096 0.80%
chemicals
Consumer/ Industrial
18 226,447 1,526 0.67% 1,154 0.51%
products
Real estate,
infrastructure, power 05 566,982 1,637 0.29% 1,009 0.18%
and utilities
Total 77 3,381,439 152,370 4.51% 110,151 3.26%
25 Transitioning to new leasing standard – Ind AS 116Impact on financial statements
INR crores
Potential impact on financials as on 31 March 2019 — Sector perspective
Change in (increase or decrease)
Finance
No. of Lease Deprec- Profit/
Sector cost EBITDA PPE Liability
co.s expense iation Equity
Airlines 02 (5,482) 4,322 1,742 5,482 11,516 12,097 (582)
Retail 03 (1,425) 1,040 601 1,425 4,426 4,643 (216)
Telecom 02 (7,414) 5,325 3,279 7,414 24,481 25,671 (1,190)
Technology (IT/IES) 06 (2,576) 1,923 1,010 2,576 7,254 7,611 (357)
Oil and gas 07 (16,363) 13,372 4,161 16,363 24,455 25,626 (1,170)
Media and
02 (126) 108 24 126 107 113 (6)
entertainment
Transportation and
04 (50) 38 19 50 133 140 (7)
logistics
Automobiles and
10 (1,163) 850 486 1,163 3,568 3,741 (173)
transportation
Mining and metals 08 (1,033) 753 437 1,033 3,221 3,378 (157)
Healthcare,
pharmaceutical and 10 (357) 277 121 357 819 860 (41)
chemicals
Consumer/ Industrial
18 (398) 313 127 398 842 883 (42)
products
Real estate,
infrastructure, power 05 (267) 193 111 267 815 853 (37)
and utilities
Total 77 (36,654) 28,514 12,118 36,654 81,637 85,616 (3,978)
INR 81,637crore INR 36,654 crore
Increase in property plant and Increase in earning before interest, tax,
equipment depreciation and amortization
INR 28,514 crore
Increase in depreciation
INR 85,616 crore INR 12,118 crore
Increase in liability Increase in finance cost
INR 3,978 crore INR 36,654 crore
Decrease in equity and profit Decrease in rental expense
Transitioning to new leasing standard – Ind AS 116 26Impact on financial ratios
INR crores
Potential impact on financials as on 31 March 2019 — Sector perspective
Sector No. Interest coverage ratio Debt equity ratio EBIDTA to sales ratio
of
co.s
IND IND IND IND IND IND
AS 116 AS 17 AS 116 AS 17 AS 116 AS 17
Airlines 02 1.87 5.17 (0.30) (0.41) 21.57% 10.00%
Retail 03 6.00 7.96 2.86 2.03 9.73% 5.95%
Telecom 02 7.79 39.12 1.40 1.18 62.05% 55.23%
Technology (IT/IES) 06 64.12 144.50 0.39 0.37 29.20% 28.39%
Oil and gas 07 11.28 14.39 1.53 1.44 13.04% 12.24%
Media and
02 146.38 804.24 0.31 0.30 57.49% 56.38%
Entertainment
Transportation and
04 53.35 71.44 0.61 0.54 17.98% 16.81%
logistics
Automobiles and
10 556.14 602.88 1.21 1.20 19.07% 18.98%
transportation
Mining and metals 08 31.80 31.83 1.95 1.94 29.83% 29.73%
Healthcare,
pharmaceutical and 10 97.94 105.78 0.89 0.88 25.43% 25.18%
chemicals
Consumer/ Industrial
18 61.98 65.41 0.92 0.91 20.44% 20.26%
products
Real estate,
Infrastructure, power 05 4.55 4.64 1.92 1.91 76.18% 76.00%
and utilities
Total 77 116.11 148.71 1.16 1.10 27.04% 26.08%
Based on the assumptions and assessments in the previous section, the impact on financial metrics on account of bringing the
off-balance sheet leases on the balance sheet is presented above.
► Interest coverage ratio: EBIT will increase applying Ind AS 116 as well as interest expense. The change in the ratio will
depend on the characteristics of the lease portfolio.
► Debt equity ratio: Financial liabilities are expected to increase and equity is expected to decrease. The change in the ratio
will depend on the characteristics of the lease portfolio.
► EBIDTA to sales ratio: Expected effect that EBIDTA to sales ratio would increase as EBITDA will increase whereas there is
no impact on revenue.
27 Transitioning to new leasing standard – Ind AS 116How to navigate change
Based on our experience from similar projects where we assisted various clients, we believe that
following are the critical factors to effectively manage this type of engagement:
Understand
Process
Understand the current leasing landscape of the company
with special emphasis on lease and service contracts,
understand the nature of lease contracts, volume of leasing
arrangements and other contracts which may be classified
as leases
IT Review
Review customer contracts, understand and analyze the key terms
of such contracts in light of possible impacts of new guidance
Identify
Based on understanding and review of contracts, identify
Organization changes resulting from the new lease standard (e.g., data
gaps, processes, controls, systems and tax),
Specially focus on contracts not classified as lease contracts
previously
Abstract and evaluate
Quantify the accounting impact on transition,
Tools
disclosures and key financial metrics; Design
solution for accounting change (e.g. new
accounting policies, processes, controls and
systems) to capture new lease data requirements
and understand financial statement impact.
Project Conclude
Coordination
Arrive at conclusion of potential impact on overall financial
statements (number impact, enhanced disclosure requirements
and likely impact on key metrics) of the company based on
selected sample
Transitioning to new leasing standard – Ind AS 116 28Advent of new-era The new standard may pose significant implementation challenges. Based on experiences of some of the large global organizations reporting under ASC 842 or IFRS 16 – it is certain that Indian companies would need to be well prepared and start early for this transition. As is evident from our analysis of the companies in-scope (refer Appendix 4), the new standard would affect wide variety of sectors and entities, specially the ones in airlines, retail, power generation, oil and gas and others with large lease portfolio. For certain sectors – the business impact could be significant on “buy” or “lease” decisions. Additional focus may be required for outsourcing contracts, third-party manufacturing contracts, power purchase agreements and other service arrangements. Lease accounting change is more than accounting and more than change. It can mean opportunity. Companies that will handle the transitions smartly may find themselves equipped with an array of improvements — state-of-the-art IT, upgraded systems, processes and controls and perhaps even a transformed operating model. If the companies frame their accounting change efforts right, compliance may become the catalyst for added value, positioning them to take advantage of new capabilities and insights into their business. At the core of the challenge that companies face is the complexity of taking on big changes at essentially the same time. Implementation of multiple standards may overlap in places and prove to be a logistical challenge to many companies. The implementation would require a significant mind-set shift and a strong resolve to make suitable changes to processes, systems and IT environment of the organization. It would require involvement of multiple stakeholders. Indian regulators and corporates have demonstrated exceptional resilience and embraced changes gracefully over past few years and it is expected that new standard on leasing will be dealt with in a similar manner.
Appendices ► Appendix 1: Transition provisions ► Appendix 2: Key disclosures ► Appendix 3: Key differences with current Ind AS ► Appendix 4: List of companies
Appendix 1: Transition provisions
Lessees are permitted to choose between two transition approaches applied consistently to all leases, either the full
retrospective approach or the modified retrospective approach.
Retrospective application or modified approach?
Option 1 – Retrospective Option 2 – Modified (Do not change comparative FS)
► Restate comparatives as if Ind AS 116 always ► Difference between asset and liability recognized in
applied opening RE at transition date.
► Operating leases:
► Calculate present value of remaining lease
payments for existing operating leases using
incremental borrowing rate at date of transition
► Choose how to measure ROU asset on lease-by-
lease basis:
Option 2A – Option 2B –
► Measure asset as if Ind AS 116 ► Measure asset at amount equal
had been applied from lease to liability (adjusted for accruals
commencement (but using and prepayments)
incremental borrowing rate at
date of transition)
A lessor is not required to make any adjustments on transition for leases in which it is a lessor and shall account for those
leases applying this Standard from the date of initial application except in the case of subleases. An intermediate lessor (i.e.,
an entity that is both the lessee and lessor of the same underlying asset) reassesses each existing operating sublease at the
date of initial application to determine whether it is classified as an operating lease or a finance lease under the requirements
of Ind AS 116.
If a sublease was classified as an operating lease under Ind AS 17, but is classified as a finance lease under Ind AS 116, the
intermediate lessor accounts for the sublease as a new finance lease entered into on the date of initial application. Any gain
or loss arising on the sublease arrangement is included in the cumulative catch-up adjustment to retained earnings (or other
component of equity, as appropriate) at the date of initial application.
31 Transitioning to new leasing standard – Ind AS 116Appendix 2: Key disclosures
In the books of lessees
All leases
Balance sheet ► Carrying amount of right-of-use assets at the end of the reporting period by class of
underlying asset
► Additions to right-of-use assets
Statement of profit ► Depreciation charge for right-of-use assets by class of underlying asset
and loss
► Interest expense on lease liabilities
► Variable lease expense, i.e., for variable lease payment not included in the lease liability
► Short-term lease expense for such leases with a lease term greater than one month
► Low-value asset lease expense (except for portions related to short-term leases)
► Income from subleasing right-of-use assets
► Gains and losses arising from sale and leaseback transactions
Statement of cash ► Total cash out flow for leases
flow
Other quantitative and ► Maturity analysis of lease liabilities
qualitative information
► Amount of its lease commitments for short-term leases when short-term lease commitments
at the end of the reporting period are dissimilar to same period’s short-term lease expense
► The nature of the lessee’s leasing activities
► Future cash outflows to which the lessee is potentially exposed that are not reflected in the
measurement of lease liabilities:
► Variable lease payments
► Extension options and termination options
► Residual value guarantees
► Leases not yet commenced to which the lessee is committed
► Restrictions or covenants imposed by leases
► Sale and leaseback transactions
► Facts of short term leases or leases of low- value assets
► Disclosure requirements of Ind AS 40 if right of use asset meet definition of investment
property
► Disclosure requirement of Ind AS 16 if right of use asset measure at revalued amount by
applying Ind AS 16
Transitioning to new leasing standard – Ind AS 116 32Appendix 2: Key disclosures (cont’d.)
In the books of lessors
Finance leases
Balance sheet ► Significant changes in the carrying amount of the net investment in finance leases
Statement of profit ► Finance income on the net investment in the lease
and loss
► Income relating to variable lease payments not included in the measurement of the net
investment in the lease
► Selling profit or loss at the time of sale of assets under finance lease
Statement of cash ► Total cash out flow for leases
flow
Other quantitative and ► Maturity analysis of lease payments receivable showing the undiscounted lease payments to
qualitative information be received on an annual basis for a minimum of each of the first five years and a total of
the amounts for the remaining years
► Reconciliation of the undiscounted lease payments to the net investment in the lease
► The nature of the lessor’s leasing activities
► Risk management strategy for the rights it retains in the underlying assets. E.g., buy-back
agreements, residual value guarantees or variable lease payments for use in excess of
specified limits
Operating leases
Statement of profit ► Lease income
and loss
► Income relating to variable lease payments that do not depend on an index or a rate
Other quantitative and ► Maturity analysis of lease payments receivable showing the undiscounted lease payments to
qualitative information be received on an annual basis for a minimum of each of the first five years and a total of
the amounts for the remaining years
► Disclosure requirements required by Ind AS 16, Ind AS 36, Ind AS 38, Ind AS 40 and Ind AS
41 for assets subject to an operating lease
► The nature of the lessor’s leasing activities
► Risk management strategy for the rights it retains in the underlying assets. E.g., buy-back
agreements, residual value guarantees or variable lease payments for use in excess of
specified limits
33 Transitioning to new leasing standard – Ind AS 116Appendix 3: Key differences with
current Ind AS
The following is a summary of the key differences between Ind AS 116 and Ind AS 17
Ind AS 116 Ind AS 17
Definition of a lease Under Ind AS 116, a lease is a contract, or Ind AS 17 defines a lease as an agreement
part of a contract, that conveys the right to whereby the lessor conveys to the lessee, in
control the use of an asset (the underlying return for a payment or series of payments,
asset) for a period of time in exchange for the right to use an asset for an agreed period
consideration. of time. Under Appendix C Determining
whether an Arrangement contains a Lease, it
To determine if the right to control conveys
is not necessary for an arrangement to
to the customer, an entity assesses whether,
convey the right to control the use of an
throughout the period of use, the customer
asset to be in scope of Ind AS 17.
has the right to obtain substantially all of the
economic benefits from use of the identified
asset and the right to direct the use of the
identified asset.
Short term leases Lessees can elect, by class of underlying There is no exemption for leases with a
lessees asset to which the right of use relates, to remaining lease term less than 12 months.
apply a method similar to Ind AS 17 operating
lease accounting, to leases with a lease term
of 12 months or less and without a purchase
option.
Leases of low value Lessees can elect, on a lease-by-lease basis, There is no exemption for leases for which
assets - lessees to apply a method similar to Ind AS 17 the underlying asset is of low value.
operating lease accounting, to leases of low-
value assets (e.g., tablets and personal
computers, small items of office furniture and
telephones).
Lease classification – Lessees apply a single recognition and Lessees apply a dual recognition and
lessees measurement approach for all leases, with measurement approach for all leases.
options not to recognize right-of-use assets
Lessees classify a lease as a finance lease if it
and lease liabilities for leases for short-term
transfers substantially all the risks and
leases and leases of low-value assets.
rewards incidental to ownership. Otherwise a
lease is classified as an operating lease.
Lease payments At the commencement date, lessees (except At the commencement of the lease term,
included in the initial short-term leases and leases of low-value lessees recognize finance leases as assets
measurement - assets) measure the lease liability at the and liabilities in their statements of financial
lessees present value of the lease payments to be position at amounts equal to the fair value of
made over the lease term. the leased property or, if lower, the present
value of the minimum lease payments, each
determined at the inception of the lease.
Transitioning to new leasing standard – Ind AS 116 34You can also read
