Ind AS 116 – Leases Explained: Practical Guide for CFOs

Lease accounting underwent a major transformation with the introduction of Ind AS 116 – Leases, which replaced the earlier guidance under Ind AS 17. The standard significantly changes how companies recognize and present leases in their financial statements, particularly for lessees.

Under the previous framework, many leases were classified as operating leases and kept off the balance sheet. Ind AS 116 removes this distinction for lessees and requires most leases to be recognized directly on the balance sheet. This change enhances transparency and provides stakeholders with a clearer picture of an entity’s financial commitments.

For companies applying Indian Accounting Standards (Ind AS), Ind AS 116 has important implications for financial reporting in India, including the recognition of right-of-use assets, lease liabilities, and related disclosures. CFOs, finance leaders, and controllers must therefore ensure that lease arrangements, accounting policies, and reporting processes are aligned with the requirements of the standard.

Objective of Ind AS 116

The objective of Ind AS 116 is to establish principles for the recognition, measurement, presentation, and disclosure of leases.

It requires lessees and lessors to provide information that faithfully represents the rights and obligations arising from lease arrangements.

For lessees, the standard introduces a single accounting model requiring entities to recognize assets and liabilities for most leases. This model improves transparency by reflecting lease obligations directly on the balance sheet rather than treating them as off-balance-sheet commitments.

Scope of Ind AS 116

Ind AS 116 applies to all lease arrangements, including contracts that convey the right to control the use of an identified asset for a period of time in exchange for consideration.

Examples of assets commonly leased include office premises, warehouses, manufacturing equipment, vehicles, and IT infrastructure.

However, certain arrangements fall outside the scope of the standard. These include leases related to the exploration or use of natural resources, biological assets under agricultural accounting, service concession arrangements, and certain intellectual property licensing arrangements.

The standard also provides two practical exemptions for lessees: short-term leases (12 months or less) and leases of low-value assets such as small office equipment.

Key Principles and Requirements

The most significant change introduced by Ind AS 116 is the balance sheet recognition of lease assets and liabilities for lessees.

At the commencement date of a lease, a lessee must recognize a Right-of-Use (ROU) Asset representing the right to use the leased asset and a Lease Liability representing the obligation to make lease payments.

The lease liability is measured at the present value of future lease payments discounted using the interest rate implicit in the lease or the lessee’s incremental borrowing rate.

The right-of-use asset initially includes the lease liability, lease payments made at or before commencement, initial direct costs, and estimated restoration costs.

Subsequently, the lease liability increases with interest and decreases with lease payments, while the ROU asset is depreciated over the lease term.

Practical Business Implications

Ind AS 116 has a wide-ranging impact on companies across industries.

Organizations with significant lease portfolios may see substantial increases in reported assets and liabilities. Financial ratios such as debt-to-equity, return on assets, and interest coverage ratios may also change.

Because lease expenses shift from operating expenses to depreciation and interest, EBITDA typically increases.

Companies must also maintain detailed records of lease agreements and often implement lease management tools or ERP upgrades to comply with the requirements.

Common Challenges in Implementation

Companies frequently face challenges when implementing Ind AS 116.

One challenge is identifying embedded leases in service contracts. Another involves determining lease terms when renewal options exist.

Selecting appropriate discount rates may require significant judgment. Additionally, organizations may struggle with collecting lease data across multiple locations.

Lease modifications and reassessment requirements can further complicate accounting and reporting processes.

Illustration of Ind AS 116 Accounting

Consider a company that leases office premises for five years with annual lease payments of INR 10,00,000.

At the commencement date, the company calculates the present value of lease payments using an incremental borrowing rate of 8 percent. Assume the present value of payments equals INR 39,92,000.

The company recognizes a right-of-use asset of INR 39,92,000 and a lease liability of INR 39,92,000.

This creates a lease-related asset and liability at commencement, with depreciation and interest recognized over time.

Key Disclosure Requirements

Ind AS 116 requires detailed disclosures that help stakeholders understand the financial impact of leasing arrangements.

These include the carrying amount of right-of-use assets by asset class, lease liabilities and maturity analysis, depreciation of ROU assets, interest expense on lease liabilities, expenses related to short-term or low-value leases, and total cash outflows related to leases.

How Nexdigm Can Help

Nexdigm’s CFO Services team supports organizations in implementing Ind AS 116 by reviewing lease contracts, identifying lease components, determining lease terms and discount rates, and designing appropriate accounting policies.

We also assist companies in implementing lease accounting models, improving financial reporting processes, preparing disclosures, and supporting audit readiness.

Our approach combines technical accounting expertise with practical business insights to help organizations achieve effective Ind AS compliance.