A step-by-step guide to Ind AS 116 implementation: identifying lease contracts, calculating ROU assets and lease liabilities, and managing ongoing disclosure requirements.
Identifying Leases Under Ind AS 116
Ind AS 116, mandatory for all Ind AS-compliant entities (listed companies and certain unlisted companies), fundamentally changes the lessee accounting treatment for all leases with a term exceeding 12 months and a lease liability above the low-value threshold. The first step in implementation is a comprehensive lease identification exercise — reviewing all contracts to identify those that contain a lease as defined under the standard. A contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
Common contracts that may contain embedded leases include IT hardware agreements (servers, printers), office space agreements, vehicle fleet agreements, and equipment rental contracts. The key question is whether the customer has the right to obtain substantially all the economic benefits from the use of the asset and the right to direct how and for what purpose the asset is used throughout the period of use. Contracts where the supplier has substantive substitution rights — the right to replace the asset during the contract period — do not contain a lease under Ind AS 116.
Calculating ROU Assets and Lease Liabilities
The Right-of-Use (ROU) asset and the corresponding lease liability are both calculated at the present value of future lease payments, discounted at the interest rate implicit in the lease or, if that rate cannot be readily determined, the lessee's incremental borrowing rate (IBR). The IBR is the rate the lessee would have to pay to borrow funds over a similar term to purchase a similar asset in a similar economic environment. For Indian companies, the IBR is typically derived from prevailing government bond yields adjusted for the company's credit spread and the lease tenor.
Lease payments included in the measurement of the lease liability encompass fixed payments (net of lease incentives receivable), variable payments based on an index or rate (initially measured using the index at commencement), amounts expected under residual value guarantees, and exercise price of purchase options where exercise is reasonably certain. Variable lease payments that are not based on an index or rate (such as payments contingent on usage) are excluded from the lease liability and expensed as incurred. The ROU asset is initially measured at the same amount as the lease liability, plus any lease payments made on or before commencement, plus initial direct costs, minus any lease incentives received.
Ongoing Accounting, Disclosures, and Common Issues
After initial recognition, the lease liability is measured using the effective interest method — similar to financial instrument amortisation — with the interest charge recognised in profit or loss. The ROU asset is depreciated over the shorter of the lease term and the useful life of the underlying asset using the straight-line method. The combination of interest expense on the lease liability and depreciation on the ROU asset replaces the rent expense that would have been recognised under the previous AS 19 accounting, resulting in a front-loaded expense pattern and a higher EBITDA (since the lease payment is now classified as financial and depreciation outflow rather than operating expense).
Key ongoing compliance requirements under Ind AS 116 include reassessing the lease liability whenever there is a lease modification, when the lease term assumption changes (due to exercise of extension or termination options becoming reasonably certain or uncertain), or when there is a change in future lease payments due to index/rate changes. These remeasurement triggers are more frequent in practice than initially anticipated — particularly for office leases with periodic CPI escalations — and companies should establish robust lease management systems to track these events and generate the required journal entries and disclosure schedules automatically.
