Lease accounting in India has seen transformative shifts following the implementation of Ind AS 116. According to reports, 80% of Indian companies with significant lease arrangements have experienced a material change in their financial metrics, such as EBITDA and net asset ratios. Globally, the adoption of similar lease accounting standards has brought an estimated $2 trillion in lease liabilities onto balance sheets. For Indian businesses, particularly in asset-intensive sectors like retail, aviation, and manufacturing, this change has redefined financial disclosures and business strategy.
For CFOs and business leaders, understanding these trends is not just about compliance—it’s about leveraging the insights for better financial planning and strategic decision-making.
In the era of enhanced financial transparency, Ind AS 116 ensures stakeholders—investors, regulators, and creditors—gain a clearer view of a company’s financial obligations. By aligning lease accounting in India with global standards, businesses are empowered to improve financial consistency, cross-border comparability, and investor confidence.
Ind AS 116 mandates that lessees recognize almost all leases on their balance sheets, introducing the concept of right-of-use (ROU) assets and lease liabilities. It has replaced Ind AS 17, bringing Indian accounting practices in line with global IFRS standards.
The key change is the elimination of the distinction between operating and finance leases for lessees, ensuring that all significant lease obligations are recorded. This impacts metrics such as EBITDA, where lease expenses are reclassified as depreciation and interest.
The transition from Ind AS 17 to Ind AS 116 represents a fundamental shift in how leases are accounted for by lessees in India. The Ins AS 116 standard eliminates the differentiation between operating and finance leases for lessees, requiring most leases to be recognized on the balance sheet. This shift aims to enhance transparency and provide stakeholders with a clearer view of a company’s financial obligations.
Under Ind AS 116, businesses face significant changes in how leases are recognized, measured, and disclosed. These changes not only impact financial statements but also influence key financial metrics such as EBITDA, leverage ratios, and return on assets. For CXOs and finance leaders, understanding these differences is essential for strategic decision-making and maintaining investor confidence.
Here are the key differences between erstwhile Ind AS 17 and now widely followed Ind AS 116:
| Aspect | Ind AS 17 | Ind AS 116 |
| Recognition on the Balance Sheet | Operating leases were off-balance-sheet for lessees, with lease expenses recognized on a straight-line basis over the lease term. | Lessees must recognize all leases (except short-term or low-value leases) on the balance sheet, with lease liabilities and corresponding right-of-use (ROU) assets. |
| Expense Treatment | Lease payments were categorized as operating expenses for operating leases, impacting EBITDA. | Lease expenses are replaced by depreciation (ROU assets) and interest (lease liabilities), leading to higher EBITDA. |
| Measurement and Remeasurement | Measurement was relatively static, with limited adjustments. | Lease liabilities and ROU assets are subject to remeasurement for changes in lease terms, discount rates, or variable lease payments. |
| Lease Classification | Required classification as operating or finance leases for lessees. | Eliminates the need for classification by lessees; all significant leases are treated similarly. |
| Enhanced Disclosures | Limited disclosure requirements for operating leases. | Requires comprehensive disclosures, including ROU asset details, maturity analysis of lease liabilities, and cash flow impacts. |
| Impact on Financial Metrics | Lease expenses directly reduced operating income. | Shifts the impact to depreciation and interest, improving operating income while increasing debt-related metrics like leverage ratios. |
The classification of leases under Ind AS 116 has been redefined to ensure greater consistency and alignment with global standards. Previously, the distinction between operating and finance leases had a significant impact on how leases were reported in financial statements. With Ind AS 116, the focus has shifted toward recognizing most leases on the balance sheet, thereby increasing transparency and comparability.
The three primary aspects of lease classification under Ind AS 116 include:
A. Operating Leases
Under Ind AS 17, operating leases were treated as off-balance-sheet items. However, with Ind AS 116, lessees must recognize operating leases on the balance sheet as right-of-use (ROU) assets and lease liabilities, unless the lease qualifies for exemptions (e.g., short-term or low-value leases). This change significantly impacts industries with long-term lease agreements, such as retail and logistics.
B. Finance Leases
Finance leases, which transfer significant ownership risks and rewards to the lessee, continue to be recognized on the balance sheet under Ind AS 116. Both the leased asset and the corresponding liability are recorded, ensuring the financial statements reflect the economic substance of the transaction.
C. Criteria for Lease Classification
Lease classification depends on several factors, including:
For lessees, recognition begins at the lease commencement date, where they are required to capture the lease liability and the ROU asset. The subsequent measurement ensures that these elements are updated to reflect interest, repayments, depreciation, and any changes in lease terms. Additionally, impairment testing safeguards the accuracy of financial reporting by addressing any reductions in the recoverable value of ROU assets.
A. Initial Recognition of Lease Liability and ROU Asset
Lessees must recognize:
B. Subsequent Measurement
Lease liabilities are adjusted using the effective interest rate method, while ROU assets are amortized over the lease term or asset’s useful life.
C. Impairment of Right-of-Use Asset
Testing for impairment ensures that any decline in the recoverable value of ROU assets is recorded promptly.
Two critical components in lease accounting under Ind AS 116 are determining the lease term and selecting the appropriate discount rate.
A. Determining the Lease Term
The lease term includes non-cancellable periods, as well as optional renewals or terminations that are reasonably certain.
B. Selection of the Discount Rate
Choosing the appropriate discount rate, whether the rate implicit in the lease or the lessee’s incremental borrowing rate, significantly affects lease accounting.
Ind AS 116 has transformed lease accounting in India, with significant implications for financial reporting and business strategy. For CFOs, mastering lease accounting is essential for compliance, financial planning, and strategic decision-making.
At Stratrich Consulting, we go beyond compliance to help you uncover the strategic value of lease accounting. Whether it’s implementing Ind AS 116, automating processes, or providing tailored advisory solutions, our expertise ensures your business stays ahead in the evolving financial landscape.
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