January 2019

USEFUL LIFE UNDER IND AS 16 PROPERTY, PLANT AND EQUIPMENT AND LEASE TERM UNDER IND AS 116 LEASES

Dolphy D'Souza
Chartered Accountant

QUERY

A lessee enters into a lease for an office property. The lease has a non-cancellable term of 5 years and contains an option for the lessee to extend the lease for a further 5 years. The rentals for the period under the extension option (i.e., years 6-10) are at market rates. Upon commencement of the lease term, the lessee incurs cost constructing immoveable leasehold improvements specific to the property. The useful life of the leasehold improvement is 7 years. At the commencement date of the lease, the lessee expects, but is not reasonably certain, to exercise the extension option. The economic penalty of abandoning the leasehold improvement at the end of the non-cancellable term of the lease is not so significant as to make exercise of the renewal option reasonably certain. Over what period does the lessee depreciate leasehold improvements?

 

RESPONSE

View 1 – The useful life of the leasehold improvements is 5 years

 

Appendix A to Ind AS 116 defines lease term as: “The non-cancellable period for which a lessee has the right to use an underlying asset, together with both:

u    (a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and…”

 

In this case, since the lessee is not reasonably certain to exercise the option to extend the lease, the lease term is 5 years for the purpose of Ind AS 116. 

 

Ind AS 16 (56) states that:

“…all the following factors are considered in determining the useful life of an asset:

u    (a) expected usage of the

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