July 2019

LESSEE’S LEASE OBLIGATION – BORROWINGS VS. FINANCIAL LIABILITY

Dolphy D'Souza
Chartered Accountant

ISSUE

Ind AS 17 Leases required lessees to classify leases as either finance leases or operating leases, based on certain principles, and to account for these two types of leases differently. The asset and liability arising from finance leases was required to be recognised in the balance sheet, but operating leases could remain off-balance sheet.

 

Information reported about operating leases lacked transparency and did not meet the needs of users of financial statements. Many users adjusted a lessee’s financial statements to capitalise operating leases because, in their view, the financing and assets provided by leases should be reflected on the balance sheet. Some tried to estimate the present value of future lease payments. However, because of the limited information that was available, many used techniques such as multiplying the annual lease expense by eight to estimate, for example, total leverage and the capital employed in operations. Other users were unable to adjust and so they relied on data sources such as data aggregators when screening potential investments or making investment decisions. These different approaches created information asymmetry in the market.

 

The existence of two different accounting models for leases, in which assets and liabilities associated with leases were not recognised for operating leases but were recognised for finance leases, meant that transactions that were economically similar could be accounted for very differently. The differences reduced comparability for users of financial statements and provided opportunities to structure transactions to achieve an accounting outcome.

 

To bridge the problems discussed above, IFRS 16 Leases was issued. Correspondingly, in India the Ministry of Corporate Affairs issued Ind AS 116 – ‘Leases’, which is notified and effective from 1st April, 2019 and replaces Ind AS 17. Ind AS 116 requires lessees to recognise a liability to make lease payments and a corresponding asset representing the right to use the underlying asset during the lease term for all leases, except for short-term leases and leases of low-value assets, if the lessee chooses to apply such exemptions. For lessees, this means that more liabilities and assets are recognised if they have leases, compared to the earlier standard, Ind AS 17.

--->

Keywords Search
Flip-Book Search
HTML View Search
Current Issue