Treatment of Maintenance Charges in Lease Arrangements Under Ind AS 116

1. Question

Denver Technologies Private Limited, hereinafter referred to as “the company, “is engaged in the business of manufacturing heavy engineering equipment. The company entered into a lease agreement on 1st April 2024 with Real Estates Private Ltd. for renting an office building located in Bengaluru. The lease has been executed for a non-cancellable period of three years and is intended for the company’s administrative operations.

Under the terms of the agreement, Denver Technologies (Lessee) is required to make monthly payments comprising two elements:a base rent of Rs. 1,00,000 for the use of office premises and an additional Rs. 20,000 per month towards maintenance charges, which cover cleaning, common area upkeep, lift maintenance, and security services. All payments are due at the end of each month. The company’s incremental borrowing rate has been determined at 10% per annum. The ownership of the building remains with Real Estates (Lessor), and no purchase option exists at the end of the lease term.

The management of the company, while applying Ind AS 116, Leases, is uncertain about the accounting of the component attached to the lease agreement. The company wants to understandwhether the entire monthly payment of Rs. 1,20,000 (Rs. 1,00,000 rent + Rs. 20,000 maintenance) should be treated as part of the lease payments for the purpose of measuring the Right-of-Use (ROU) asset and lease liability, or whether only the rent component of Rs. 1,00,000 should be included in the computation, with the maintenance portion recognized as a separate expense in the statement of profit and loss?

Also explain accounting treatment under Ind AS 116 by Lessor in the aforesaid scenario.

2. Relevant Provision

Ind AS 116 – “Leases”

Para 12 of Ind AS 116

For a contract that is, or contains, a lease, an entity shall account for each lease component within the contract as a lease separately from non-lease components of the contract, unless the entity applies the practical expedient in paragraph 15.

Para 15 of Ind AS 116

As a practical expedient, a lessee may elect, by class of underlying asset, not to separate non-lease components from lease components, and instead account for each lease component and any associated non-lease components as a single lease component.

Para B32 of Ind AS 116

The right to use an underlying asset is a separate lease component if the lessee can benefit from use of the underlying asset either on its own or together with other resources that are readily available to the lessee. Readily available resources are goods or services that are sold or leased separately (by the lessor or other suppliers) or resources that the lessee has already obtained (from the lessor or from other transactions or events)

Para 16 of Ind AS 116

Unless the practical expedient in paragraph 15 is applied, a lessee shall account for non-lease components applying other applicable Standards.

Para 17 of Ind AS 116

For a contract that contains a lease component and one or more additional lease or non-lease components, a lessor shall allocate the consideration in the contract applying paragraphs 73–90 of Ind AS 115.

3. Analysis

The first step in accounting for lease agreements involves identifying whether the contract contains one or more lease components and whether there are non-lease components embedded within the arrangement. In the extant case, the lease agreement clearly contains two distinct elements, a lease component relating to the right to use the office building, and a non-lease component in the form of maintenance services. Thus, as per para 12 of Ind AS 116, the lessee shall account for the lease and non-lease components separately unless it elects to apply the practical expedient under para 15. The practical expedient is an option provided by the standard that the entity may choose to use to obtain simplified accounting.

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