Practical Expedients Under Ind AS 116: A Comprehensive Guide for Lessees

Introduction

Ind AS 116, part of the revised accounting standards, introduces a unified lessee accounting model. This comprehensive model requires lessees to recognize assets and liabilities for all leases with a term exceeding 12 months, unless the underlying asset is of low value. Understanding and implementing Ind AS 116 can be complex, but it significantly impacts a lessee's financial statements by requiring them to recognize a right-of-use asset and a lease liability. This article provides a detailed insight into the practical expedients available under Ind AS 116, specifically tailored for lessees.

Recognition of Right-of-Use Asset and Lease Liability

Under Ind AS 116, lessees must recognize a right-of-use asset, which represents the right to use the underlying leased asset, and a lease liability, which reflects the lessee's obligation to make lease payments. This dual recognition ensures a transparent view of future obligations and lease-related assets on the balance sheet. As a result, lessees must also account for depreciation of the right-of-use asset and interest on the lease liability in the financial statements.

Hypothetical Example: A Lessee's Perspective

Let's take a hypothetical example to illustrate the implications of Ind AS 116 for a lessee. Suppose Company X Ltd. enters into a 5-year lease agreement with yearly lease payments of Rs.100,000, to be paid at the beginning of each year. The incremental rate of borrowing is 10%, and there are no initial direct costs to obtain the lease. The applicable income tax rate is 25%.

Financial Closures at the End of Year 1

At the end of the first year, the carrying value of the right-of-use (ROU) asset would be INR 333,589, and the lease liabilities would be INR 348,685. This recognition ensures that the lessee's financial statements reflect the true nature of the lease agreement.

Income Tax Implications

In income tax terms, only rental payments are deductible, not depreciation or finance costs. This creates a need to compute deferred tax owing to the temporary differences between the carrying amount of an asset or liability in the statement of financial position and its tax base.

Calculating Deferred Tax

The tax base of the ROU asset is zero because the tax deduction relates to the lease liability, and no tax deduction will be available for the asset. Similarly, the tax base of the lease liability is zero since it is the carrying amount of INR 348,685 less the future tax deduction of INR 348,685. These calculations are essential for accurate deferred tax reporting.

Deferred Tax Assets and Liabilities

The net deferred tax asset would likely be presented under the head "Non-Current Assets" in the financial statements. At the end of the 5-year lease term, both the ROU asset and lease liabilities will turn to zero, indicating the completion of the lease term and the cessation of leased asset usage and financial obligations.

Conclusion

Understanding and applying Ind AS 116 is crucial for lessees to provide accurate and transparent financial information. The practical expedients available under this standard help in managing the complexities of lease accounting, ensuring compliance with international accounting standards.