9 MAY 2019 -WEBCAST Ind AS Implementation Group Accounting - - PowerPoint PPT Presentation

IND AS 116, LEASES – A PRACTICAL APPROACH

9 MAY 2019 -WEBCAST

Ind AS Implementation Group Accounting Standards Board The Institute of Chartered Accountants of India, New Delhi, India

ICAI

DISCLAIMER

 The views expressed by the presenter are his personal views and based on

professional judgements

 The views of the presenter may not be construed as the conclusions or

• pinions of the Ind AS Implementation Group or the Accounting Standards

Board or that of the Institute of Chartered Accountants of India

 Due care and professional judgements may be exercised by the audience in

applying the requirements of the Standard

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STRUCTURE OF THE DISCUSSION

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A snap shot of the Standard Key Impact Areas Case Study Practical expedients Transitional Provisions The Next Steps

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A SNAPSHOT OF THE STANDARD

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Erstwhile Ind AS 17 Ind AS 116 A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time 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. Future lease payments in respect of

• perating leases are off balance sheet

items Right of use Asset is recognised with corresponding Lease liability in the balance sheet for all operating leases Operating lease payments are charged to the profit and loss as expense on a straight line basis Depreciation (on Right of use Assets) and finance costs (on Lease Liability) to be recognised in the financial statements of the Lessee

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HOW IT LOOKS LIKE?

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Assets Under Ind AS 17 Under Ind AS 116 Total existing assets 38,750 38,750 Right of use assets NA 14,500 Total Assets 38,750 53,250

Balance Sheet

Equity and Liabilities Under Ind AS 17 Under Ind AS 116 Total existing equity and liabilities 38,750 38,750 Lease Liability NA 14,500 Total Liabilities 38,750 53,250 Rs.in Lakhs

Impact on

• Debt to Equity
• ROI
• Asset Coverage
• Current Ratio
• Business

valuations

• Impact on loan

covenants

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HOW IT LOOKS LIKE?

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Particulars Under I nd AS 17 Under Ind AS 116 Profit before lease accounting 7421 7421 Operating lease expenses (451) NA Low value/ short term leases NA (98) EBITDA 6,970 7,323 Depreciation on ROU asset NA (1,450) Finance cost on Lease Liability NA (145) Profit for the period 6,970 5,728

Statement of profit and loss

Rs.in Lakhs

Impact on

• EBITDA
• Interest Cover
• Free cash accruals
• Front loading of

expenses

• PBT in initial years
• Operating cash flow
• Financing cash flow

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IDENTIFYING A LEASE

Is it a lease?

Assessment to be at inception Re-assess only if terms and conditions of contract changed

Identified Asset Right to control the use

• f an identified asset

&

Right to obtain substantially all economic benefits from use Right to direct the use

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POINTS TO PONDER

• Accounting for bundled contract containing both lease and provision of

services by Lessees

• When the supplier has a substantive substitution right
• If exists, there is no identified asset
• Substitution of the asset during repairs or maintenance periods does not,

represent a substantive right of substitution

• The ability to substitute if new technology becomes available does not

represent a substantive right of substitution

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IDENTIFIED ASSET

Portion of Identified asset?

Physically distinct portion Capacity portion

Substantially all the capacity? A minimal portion of the capacity

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LEASE TERM

Initial lease period

Reassess and revise estimate of Lease Term at every reporting period based on facts and circumstances

Reasonably certain that the option to extend will be elected Reasonably certain that the option to terminate will be elected

Extension and Termination

• ptions

to be considered in determining the lease term

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POINTS TO PONDER

The entity will need to consider all relevant facts and circumstances that create an ‘economic incentive’ for the lessee to exercise the option to extend a lease or terminate it

• Contractual terms for optional periods and market rates
• Significant leasehold improvements
• Costs of termination and return
• Importance to operations (specialised, location, alternatives)
• Conditionality associated with option

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INITIAL MEASUREMENT

Right of use asset (At cost)

Discount the lease payments to arrive at the present value of right of use asset/ lease liability

At the commence of lease, recognise right of use asset and lease liability

Lease Liability (PV of lease payments)

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DISCOUNT RATE

Interest rate implicit in the lease

Use rate implicit in the lease or Incremental borrowing rate

Incremental borrowing rate of the lessee

Lease payments shall be discounted using

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POINTS TO PONDER

• Can an entity directly use incremental borrowing rate as the discount rate?
• Implicit interest rate requires fair value of underlying asset and initial direct cost

incurred by the Lessor

• Significant judgements involved in determining incremental borrowing rate
• Similar term
• Similar security
• Similar fund required to be borrowed in a similar economic environment
• Adjustment factors may include (a) Lease Term (b) Repayment profile (c)

Credit Risk (d) Loan Security

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SUBSEQUENT MEASUREMENT Right of Use Asset

• Apply depreciation requirements in

Ind AS 16

• Depreciate
• ver

the useful life (taking extension

• ptions

into consideration)

• Test for Impairment under Ind AS

36, if indicators are existing

• Increase the lease liability to reflect

the interest

• Decrease the lease liability to reflect

payments made

Lease Liability

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CASE STUDY IN THE LESSEE’S ACCOUNTS UNDER IND AS 116

 ABC, the manufacturing company, needs to adopt the new standard Ind AS 116 Leases in

the reporting period ending 31 March 2020.

 During the preparatory works, ABC discovered that the operating lease contract related to a

machine might require some adjustments.

 ABC entered into the contract on 1 April 2017 for 5 years, annual rental payments are

Rs.1.25 Lakhs in arrears (that is, 31 March each year) and at the end of the lease term, the machine will be returned back to the lessor. The economic life of a machine is 10 years.

 How can ABC restate the contract under Ind AS 116 using both full retrospective and

modified retrospective approach?

 Use the discount rate of 10%.

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CALCULATION OF PRESENT VALUE OF LEASE PAYMENTS

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Year ending Lease payments Discount factor Present value of lease payments

31-03-2018 1,25,000 0.9091 1,13,636 31-03-2019 1,25,000 0.8264 1,03,306 31-03-2020 1,25,000 0.7513 93,914 31-03-2021 1,25,000 0.6830 85,377 31-03-2022 1,25,000 0.6209 77,615 Total 6,25,000 4,73,848

Note: Discount factor in the first year is calculated as 1/((1+10%) to the power of year 1), etc. The right of use asset equals to the lease liability at the commencement date, plus lessee’s initial direct costs, plus some other things – but in this case, we have nothing like that, so let’s just say it’s the same as the lease liability.

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JOURNAL ENTRY

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Under Ind AS 116, the initial journal entry would be Date Particulars Debit Credit

1 April 2018

Right to use asset a/c Dr 4,73,848 To Lease liability a/c 4,73,848

Subsequently, ABC needs to take care about 2 things: 1. Depreciation of the ROU asset: Let’s say it’s straight line over the lease term of 5 years, thus it’s Rs. 94,770 per year (Rs. 4,73,848/5). 2. Lease payments: Each lease payment of Rs.1,25,000 is split between the repayment of the lease liability and interest.

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CALCULATION FOR SPLITTING OF LEASE LIABILITY AND INTEREST ON REPAYMENT

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Year ending Lease liability b/f (A) Lease payment Interest (B = A*10%) Decrease in lease liability (C = 1,25,000 - B) Lease Liability c/f (D = A - C)

31-03-2018 4,73,848 1,25,000 47,385 77,615 3,96,223 31-03-2019 3,96,223 1,25,000 39,623 85,377 3,10,857 31-03-2020 3,10,857 1,25,000 31,086 93,914 2,16,942 31-03-2021 2,16,942 1,25,000 21,694 1,03,306 1,13,636 31-03-2022 1,13,636 1,25,000 11,364 1,13,636 Total 6,25,000 1,51,152 4,73,848

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PORTFOLIO APPLICATION

All leases in the portfolio have similar characteristics No material changes is expected from applying this Standard to the individual leases within that portfolio Entity shall use estimates and assumptions that reflect the size and composition of the portfolio.

Standard may be applied for a portfolio of leases

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LOW VALUE ASSETS

For leases for which the underlying asset is of low value, entity may apply Para 6 of Ind AS 116

Lease payments associated with those leases are accounted as an expense Either on a straight-line basis

• ver the lease term or another

systematic basis

Option can be applied on a lease by lease basis If a lessee subleases an asset, or expects to sublease an asset, the head lease does not qualify as a lease of a low-value asset

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SHORT TERM LEASES

Lease payments associated with those leases are accounted as an expense Either on a straight-line basis

• ver the lease term or another

systematic basis

A lease that contains a purchase option is not a short-term lease

A lease that, at the commencement date, has a lease term of 12 months or less

Option can be applied only based on class of underlying asset

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TRANSITIONAL PROVISIONS

Full retrospective approach Modified retrospective approach

A first time adopter of this Standard shall apply either

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FULL RETROSPECTIVE APPROACH

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ABC adopts Ind AS 116 in its financial statements for the year ending 31 March 2020, and that means that the transition date is 1 April 2018. We need to restate all numbers for the comparative period, too.

1.Restatement of opening balances of the earliest period presented (that is: Before 1 April 2018): a) Recognizing ROU asset and lease liability: Date Particulars Debit Credit

01-04-2018

Right to use asset a/c Dr 4,73,848 To Lease liability a/c 4,73,848

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FULL RETROSPECTIVE APPROACH (CONTINUATION)

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b) Reversal of the lease payments before 1 April 2018 under Ind AS 17 (there was just one): Date Particulars Debit Credit

01-04-2018

Cash a/c Dr 1,25,000 To Retained earnings a/c 1,25,000

c) Accounting for the lease payments before 1 April 2018 under Ind AS 116 (there was just one): Date Particulars Debit Credit

01-04-2018

Lease liability a/c Dr 77,615 Retained earnings a/c Dr 47,385 To Cash a/c 1,25,000

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FULL RETROSPECTIVE APPROACH (CONTINUATION)

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d) Accounting for the depreciation of the ROU asset before 1 April 2018 under Ind AS 116 (there was just one year): Date Particulars Debit Credit

01-04-2018

Retained earnings (equity) a/c Dr 94,770 To Right of use asset a/c 94,770

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FULL RETROSPECTIVE APPROACH (CONTINUATION)

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All 4 entries can be combined in one adjustment and it would look something like: Date Particulars Debit Credit

01-04-2018

Right of use asset a/c Dr (4,73,848 less depreciation of 94,770) 3,79,079 Retained earnings a/c Dr (-1,25,000+47,385+94,770, or see table 3 for the year 2018) 17,154 To Lease liability a/c (4,73,848 less the lease liability repayment of 77,615, or see table 2 for the year 2018) 3,96,233

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FULL RETROSPECTIVE APPROACH (CONTINUATION)

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• 2. Restatement of the comparative period (year ended March 31, 2019):

Date Particulars Debit Credit

31-03-2019 Lease Liability a/c Dr 85,377 Interest (profit or loss for the year ended 31, March 2019) 39,623 Depreciation (profit or loss for the year ended 31, March 2019) 94,770 To Right to use asset a/c 94,770 To Operating lease expenses (profit or loss for the year ended 31, March 2019) 1,25,000

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FULL RETROSPECTIVE APPROACH (CONTINUATION)

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• 3. Restatement of the current period (year ending March 31, 2020):

Date Particulars Debit Credit

31-03-2020 Lease Liability a/c Dr 93,914 Interest (profit or loss for the year ending 31, March 2020) 31,086 Depreciation (profit or loss for the year ending 31, March 2020) 94,770 To Right to use asset a/c 94,770 To Operating lease expenses (profit or loss for the year ending 31, March 2020) 1,25,000

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FULL RETROSPECTIVE APPROACH – STATEMENT OF FINANCIAL POSITION (EXTRACT)

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Statement of financial position (extract)

Particulars March 31, 2020 March 31, 2019 (restated) 01-04-2018 (restated) ROU asset 1,89,539 2,84,309 3,79,079 Equity – accumulated profit (effect of restatement) 27,403 26,548 17,155 Lease liability Long term 1,13,636 2,16,942 3,10,857 Short term 1,03,306 93,914 85,377 2,16,942 3,10,857 3,96,233

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FULL RETROSPECTIVE APPROACH – STATEMENT OF COMPREHENSIVE INCOME (EXTRACT)

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Statement of comprehensive income (extract)

Particulars March 31, 2020 March 31, 2019 (restated) Depreciation of ROU asset 94,770 94,770 Interest (lease liability) 31,086 39,623

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MODIFIED RETROSPECTIVE APPROACH

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 Under the modified approach, ABC needs to make an equity adjustment on 1 April 2019 – that is at the beginning of the current reporting period.  Comparative numbers remain the same as presented before – so no restatement.  This is a way easier method to apply than the full retrospective approach, because you do not restate the previous years’ numbers.  However, the price for this relief is lower comparability.  It is quite difficult to compare current year under Ind AS 116 with the previous year under Ind AS 17 and it does not say much about how your leases developed.

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MODIFIED RETROSPECTIVE APPROACH – JOURNAL ENTRIES

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• 1. Restatement of opening balances at 1 April 2019:

a) Recognizing ROU asset and lease liability: Date Particulars Debit Credit

1-04-2019

Right to use asset a/c Dr 4,73,848 To Lease liability a/c 4,73,848

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MODIFIED RETROSPECTIVE APPROACH – JOURNAL ENTRIES (CONTINUATION)

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b) Reversal of the lease payments before 1 April 2019 under Ind AS 17 (there was two): Date Particulars Debit Credit

1-04-2019

Cash a/c Dr 2,50,000 To Retained earnings a/c 2,50,000

c) Accounting for the lease payments before 1 April 2019 under Ind AS 116 (there was two): Date Particulars Debit Credit

1-04-2019

Lease liability a/c Dr 1,62,992 Retained earnings a/c Dr 87,008 To Cash a/c 2,50,000

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MODIFIED RETROSPECTIVE APPROACH – JOURNAL ENTRIES (CONTINUATION)

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d) Accounting for the depreciation of the ROU asset before 1 April 2019 under Ind AS 116 (there were two years): Date Particulars Debit Credit

1-04-2019

Retained earnings (equity) a/c Dr 1,89,539 To Right of use asset a/c 1,89,539

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MODIFIED RETROSPECTIVE APPROACH – JOURNAL ENTRIES (CONTINUATION)

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Similarly as with the full approach, we can make one aggregate entry instead of these four: Date Particulars Debit Credit

01-04-2019

Right of use asset a/c Dr (4,73,848 less depreciation of 94,770*2) 2,84,309 Retained earnings a/c Dr (-2,50,000+87,008+1,89,539, or see table 3 for the years 2018 and 2019) 26,548 To Lease liability a/c (4,73,848 less the lease liability repayments of 77,615 and 85,377, or see table 2 for the years 2018 and 2019) 3,10,857

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MODIFIED RETROSPECTIVE APPROACH – JOURNAL ENTRIES (CONTINUATION)

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• 2. Restatement of the current period (year ending March 31, 2020):

Date Particulars Debit Credit

Lease Liability a/c Dr 93,914 Interest (profit or loss for the year ending 31, March 2020) 31,086 Depreciation (profit or loss for the year ending 31, March 2020) 94,770 To Right to use asset a/c 94,770 To Operating lease expenses ((profit or loss for the year ending 31, March 2020) 1,25,000

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MODIFIED RETROSPECTIVE APPROACH – STATEMENT OF FINANCIAL POSITION (EXTRACT)

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Statement of financial position (extract)

Particulars March 31, 2020 March 31, 2019 ROU asset 1,89,539 Equity - accumulated profit (effect of restatement) 27,403 Lease liability Long term 1,13,636

• Short term

1,03,306

• 2,16,942

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MODIFIED RETROSPECTIVE APPROACH – STATEMENT OF COMPREHENSIVE INCOME (EXTRACT)

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Statement of comprehensive income (extract)

Particulars March 31, 2020 March 31, 2019 Operating lease expenses

• 1,25,000

Depreciation of ROU asset 94,770

• Interest (lease liability)

31,086

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KEY IMPACTS – A RECAP

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Profit in the initial years of lease EBITA Return on capital employed Net debt and gearing ratio Current Ratio Net assets Asset retirement

• bligation

Volatility of profit

• r loss

Need for renegotiating lease contracts

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NEXT STEPS

• Impact

assessment

• f

the new Standard as a lessee

• Decide on Transitional Options
• Create

stakeholders’ awareness, especially in respect

• f

listed companies

• Applying the Standard for June 2019

quarter

• Whether any contracts has to be

renegotiated

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