All-About Ind AS 116 – Leases with Basis of Conclusion

Scope – Basis for Conclusion | [Based on Official Pronouncements of International Accounting Standard Board (IASB)]

Accordingly, Ind AS 116 contains scope exceptions for:

• • • leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources. Ind AS 116 Exploration for and Evaluation of Mineral Resources specifies the accounting for rights to explore for and evaluate mineral resources.
    • leases of biological assets within the scope of Ind AS 41 Agriculture held by a lessee. Ind AS 41 specifies the accounting for biological assets, other than bearer plants, which are within the scope of Ind AS 16. Consequently, leases of bearer plants such as orchards and vineyards held by a lessee are within the scope of Ind AS 116.
    • service concession arrangements within the scope of Ind AS 115.
    • licences of intellectual property granted by a lessor within the scope of Ind AS 115. There are specific requirements relating to those licences within Ind AS 115.
    • leases of intangible assets held by a lessee.

Service Concession Arrangements

Intangible Assets

Ind AS 116 also states that a lessee may, but is not required to, apply Ind AS 116 to leases of other intangible assets. The intention was not want to prevent a lessee from applying Ind AS 116 to leases of intangible assets for which there are no specific requirements in other Standards. It was acknowledged that there is no conceptual basis for excluding leases of intangible assets from the scope of Ind AS 116 for lessees. However, it was concluded that a separate and comprehensive review of the accounting for intangible assets should be performed before requiring leases of intangible assets to be accounted for applying the requirements of Ind AS 116. Many stakeholders agreed with this approach.

Onerous Contracts

• • • •  for leases that have already commenced, no requirements are necessary. After the commencement date, an entity will appropriately reflect an onerous lease contract by applying the requirements of Ind AS 116. For example, a lessee will determine and recognise any impairment of right-of-use assets applying Ind AS 36 Impairment of Assets.
      • for leases that have not already commenced, the requirements for onerous contracts in Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets are sufficient. The requirements in Ind AS 37 apply to any contract (and hence any lease contract) that meets the definition of an onerous contract in that Standard.

Subleases

Inventory

Non-Core Assets

Although some favoured such an approach, it was noted that:

• • • • defining ‘core’ and ‘non-core’ would be extremely difficult. For example, would office buildings used by a bank be a core asset, and would the conclusion be different if the bank has retail banking operations? Would an entity consider some offices or cars to be core assets and others non-core? If core assets were defined as those essential to the operations of an entity, it could be argued that every lease would be a lease of a core asset. Otherwise, why would an entity enter into the lease?
      • different entities might interpret the meaning of non-core assets differently, thereby reducing comparability for users of financial statements.
      •  other Standards do not distinguish between core and non-core purchased assets. Because of this, it would be difficult to justify distinguishing a right-of-use asset relating to a core asset from one that relates to a non-core asset.

Consequently, Ind AS 116 does not make any distinction in accounting on the basis of whether the underlying asset is core to an entity’s operations.

Long-Term Leases of Land

• • • • there is no conceptual basis for differentiating long-term leases of land from other leases. If the contract does not transfer control of the land to the lessee, but gives the lessee the right to control the use of the land throughout the lease term, the contract is a lease and should be accounted for as such.
      • for a long-term lease of land (for example, a 99-year lease), the present value of the lease payments is likely to represent substantially all of the fair value of the land. In this case, the accounting applied by the lessee will be similar to accounting for the purchase of the land. If the lessee obtains control of the land, it will account for the contract as the purchase of the land by applying Ind AS 16 Property, Plant and Equipment, rather than by applying Ind AS 116.

Leases of Investment Property at Fair Value

Embedded Derivatives

Short-Term Leases

Nature of the Exemption

• • • Considerations were made for simplifying the measurement requirements for short-term leases. Specifically, considerations were made for exempting lessees from the requirement to discount the payments used to measure the assets and liabilities arising from short-term leases. Many stakeholders, however, thought that this exemption would provide insufficient cost relief for lessees because it would still require an entity to track a possibly large volume of leases of a low value.
    • It was concluded that, even with simplified measurement requirements, the benefits of requiring a lessee to recognise right-of-use assets and lease liabilities for short-term leases would not outweigh the associated costs. Consequently, paragraph 5(a) of Ind AS 116 permits a lessee to elect not to apply the recognition requirements to short-term leases. Instead, a lessee can recognise the lease payments associated with short-term leases as an expense over the lease term, typically on a straight-line basis. It was decided that this choice should be made by class of underlying asset.
    • In the light of the feedback that an exemption for short-term leases did not provide sufficient relief for leases of low-value assets, a separate exemption for those leases was developed.

Definition of ‘Short-Term’

• • • It was considered to define a short-term lease as a lease that, at the commencement date, has a maximum possible term of 12 months or less. However, many thought that a short-term lease exemption defined in this way would provide limited cost relief for lessees. It was noted that, practically, a lease rarely has a maximum possible term of 12 months or less. For example, some suggested that many leases that run month-to-month would not qualify for the exemption.
    • In the light of these, it was considered to expand the short-term lease exemption to leases of more than 12 months. Some had suggested that ‘short-term’ should be up to five years. However, this approach was not adopted because, for example, three-year leases are more likely to give rise to material assets and liabilities than 12 month leases, and the objective of the standard was to ensure greater transparency about an entity’s leasing activities.
    • Instead, it was decided to expand the short-term lease exemption by making the determination of duration of short-term leases consistent with the determination of lease term, thus considering the likelihood of extension options being exercised or termination options not being exercised. Accordingly, Ind AS 116 defines a short-term lease as a lease that, at the commencement date, has a lease term of 12 months or less.
    • In reaching this decision, there was a risk that leases could be structured to meet the short-term lease exemption. It was concluded that this risk is mitigated by the economic consequences of a short-term lease for a lessor. There would often be an economic disincentive for lessors to grant shorter term leases, because shortening the lease term would increase the risk associated with a lessor’s residual interest in the underlying asset. Consequently, the view was that a lessor would often either demand increased lease payments from the lessee to compensate for this change in risk or refuse to shorten the non-cancellable period of the lease. In addition, it was noted the rigour that lessees are expected to apply when determining the lease term, as described in paragraphs B37-B40 of Ind AS 116. This should reduce the risk of non-substantive break clauses being inserted within contracts solely for accounting purposes. It was also decided that a lessee should reassess the lease term of a short-term lease by treating it as a new lease if that lease term changes.
    • It was observed that little incremental information would be lost by defining short-term leases by reference to the Ind AS 116 determination of lease term, instead of the maximum possible term. That is because a lessee would include only lease payments for the duration of the lease term as an asset and a liability, irrespective of the maximum possible term. For example, for a lease with an extension option after six months which the lessee is not reasonably certain to exercise, the lease term is six months. If that lease were not captured by the short-term lease exemption (because the maximum term is longer than the lease term), the lessee would include only lease payments for the six-month lease term in measuring the asset and liability. Consequently, by aligning the determination of short-term with the determination of lease term, the only incremental change in information would be that the lessee would no longer reflect the six months of lease payments on its balance sheet.
    • It was also considered whether identifying short-term leases using the Ind AS 116 determination of lease term would be more complex to apply, because more judgement would be needed to identify that lease term than the maximum term. However, on the basis of feedback received, it was concluded that any additional complexity in determining the lease term would be more than compensated for by the additional cost relief provided overall as a result of:

a. applying the exemption to a wider group of leases; and

b.  requiring lessees to perform only one assessment of lease term for the purposes of both identifying whether the lease is a short-term lease and measuring the assets and liabilities for leases that are not short-term.

• • • It was also decided to require a lessee to disclose the expense related to short-term leases for which the lessee has elected to apply the short-term lease exemption (see paragraph 53(c) of Ind AS 116). This disclosure provides useful information to users of financial statements about the lease payments that are excluded from lease liabilities as a consequence of the short-term lease exemption.

Leases of Low-Value Assets

• • • As noted in paragraphs above, many lessees expressed concerns about the costs of applying the requirements of Ind AS 116 to leases that are large in number but low in value. Many suggested that such an exercise would require a significant amount of effort with potentially little effect on reported information.
    • In the light of these concerns, it was decided to provide a recognition exemption for leases of low-value assets. Consequently, Ind AS 116 permits a lessee to elect, on a lease-by-lease basis, not to apply the recognition requirements of Ind AS 116 to leases for which the underlying asset is of low value.
    • In developing the exemption, an attempt was made to provide substantive relief to preparers while retaining the benefits of the requirements in Ind AS 116 for users of financial statements. The intention of exemption was to apply to leases for which the underlying asset, when new, is of low value (such as leases of tablet and personal computers, small items of office furniture and telephones). At the time of making decisions previously, the view was regarding leases of underlying assets with a value, when new, in the order of magnitude of US$5,000 or less. A lease will not qualify for the exemption if the nature of the underlying asset is such that, when new, its value is typically not low. It was also decided that the outcome of the assessment of whether an underlying asset is of low value should not be affected by the size, nature, or circumstances of the lessee – i.e. the exemption is based on the value, when new, of the asset being leased; it is not based on the size or nature of the entity that leases the asset.
    • Fieldwork was conducted to assess the effect that low-value asset leases would have if the right-of-use assets and lease liabilities were recognised in the financial statements of lessees. On the basis of this fieldwork, it was observed that, in most cases, assets and liabilities arising from leases within the scope of the exemption would not be material, even in aggregate. Consideration was whether these findings demonstrated that the exemption would be of limited benefit to lessees because most leases that would be within its scope might instead be excluded from the recognition requirements of Ind AS 116 by applying the concept of materiality in the Conceptual Framework and in Ind AS 1. However, in the light of feedback received from preparers of financial statements, it was concluded that the exemption would provide substantial cost relief to many lessees (and, in particular, smaller entities) by removing the burden of justifying that such leases would not be material in the aggregate.
    • The risk was that the aggregate value of leases captured by the exemption might be material in some cases. Fieldwork suggested that the aggregate value is most likely to be material for large assets made up of a number of individual leases of low-value assets (such as IT equipment made up of individually low-value component parts). Consequently, it was decided that if an underlying asset is highly dependent on, or highly interrelated with, other underlying assets, a lessee should not apply the recognition exemption to the lease of that individual asset. Similarly, it was decided that a lessee should not apply the recognition exemption to a lease of an underlying asset if the lessee cannot benefit from that underlying asset on its own or together with other readily available resources, irrespective of the value of that underlying asset.
    • It was decided that the recognition exemption for leases of low-value assets should be applied on a lease-by-lease basis. A requirement to apply the exemption by class of underlying asset, instead of lease-by-lease, would have introduced a burden on lessees to assess every individual asset within a class. Consequently, the recognition exemption for leases of low-value assets will be easier to apply, and of more benefit to lessees, if applied on a lease-by-lease basis.
    • It was also decided to require a lessee to disclose the amount of the expense recognised related to leases of low-value assets for which the lessee has elected to apply the recognition exemption (see paragraph 53(d) of Ind AS 116). This disclosure provides useful information to users of financial statements about the amount of lease payments that are excluded from lease liabilities as a consequence of a lessee applying the exemption relating to leases of low-value assets.