Accounting

Tax

Insights into Ind AS 116 Global

Lease payments
At the commencement of a lease, Ind AS 116 requires a lessee Fixed payments
to measure the lease liability at the present value of the lease
payments that are not paid at that date. This liability includes Fixed payments are payments, excluding variable payments,
both fixed payments (including in-substance fixed payments) that are made to the lessor by the lessee for the right to use an
and variable lease payments that depend on an index or rate, underlying asset during the lease term. These are included in
and represents the starting point for the measurement of the the lease liability at the commencement date.
related right-of-use asset.

Deciding which payments need be recognised in the In-substance fixed lease payments
measurement of the liability and how changes in those
payments are recognised often involves considerable The lessee must include in the lease liability any in-substance
judgement. This article aims to help you with this judgement. fixed lease payments. In-substance fixed lease payments are
Lease payments used to measure the lease liability at payments whose form appears to contain some variability
commencement date include the following (to the extent they although they are, in substance, unavoidable. This can occur
have not yet been paid): where:
• Fixed payments – Including in-substance fixed payments • payments are structured as variable but there is no genuine
(described further below) less any lease incentives variability in those payments
receivable • there is more than one set of payment options described in
• Variable lease payments that depend on an index or a rate the lease but only one set of those payments is realistic, or
(described further below) • there is more than one realistic set of payments described
• Amounts expected to be payable by the lessee under in the lease, but the lessee must select at least one of those
residual value guarantees sets of payments
• The exercise price of a purchase option if the lessee is
reasonably certain to exercise that option
• Payments of penalties for terminating the lease if the lease
term reflects the lessee exercising an option to terminate
the lease.

We will discuss some of these areas in more detail below.

Examples of payments lacking genuine variability include:
Example 2 – Variable lease payments dependent on
• payments that must be made only if an event occurs that
an index
has no genuine possibility of not occurring
Entity Q enters into a 10-year lease of a property with
• payments that must be made only if an asset is proven to annual payments of INR 5,000 payable at the beginning
be capable of operating during the lease of each year. The agreement specifies that the lease
payments will increase every two years based on the
• payments that are initially structured as variable lease increase in the consumer price index for the preceding 24
payments linked to the use of an underlying asset, months. The Consumer Price Index at commencement is
but for which the variability will be resolved after the 125. Entity Q estimates its incremental borrowing rate at
commencement date such that the payments become fixed 5% per annum, ie the fixed rate at which it could borrow
for the remainder of the term (in this case the payments for the amount equivalent to the value of the right-of-use
become in-substance fixed and are included in the lease assets for the same term and in the same currency.
liability only once the variability is resolved).
Analysis
The above examples are all variable in legal form but should be
At commencement, Entity Q measures the lease
treated as in-substance fixed.
liability at INR 35,539, being the present value of the
Example 1 – Minimum lease payments with more than remaining nine payments of INR 5,000 discounted at
one set of payments 5%. It measures the right-of-use asset at INR 40,539,
P is an established Motorway Service Area operator. P being the present value of the lease liability plus the
leases a Motorway Service Area and under the terms of INR 5,000 lease payment made at commencement.
the lease, P must keep the Service Area open 24 hours per
At the end of year two, the lease liability is INR
day and cannot sublease the Service Area. Annual rentals
33,932, being the present value of the eight
are payable under the contract as follows:
remaining payments of INR 5,000. The consumer
• INR 100,000 if no sales are made at the service area; or price index is 135, and the rental payment for year
• INR 10,000,000 if any sales are made during the year. three is set at INR 5,400, being “INR 5,000 X 135 /
125”.
Analysis
P concludes that the lease contains in-substance Because there is a change in the future lease
fixed lease payments of INR 10,000,000 per annum, payments, Entity Q remeasures the lease liability to
on the basis that there is no realistic possibility that reflect the net present value of the eight remaining
P will make no sales at the Service Area, as P is an payments of INR 5,400, discounted at the original
established Motorway Service Area operator, with a discount rate of 5%. This increases the lease liability
history of successful operations. by INR 2,714. This is the difference between the lease
liability of INR 33,932 and the remeasured liability of
INR 36,646. A corresponding adjustment is made to
the right-of-use asset.

Variable lease payments

Variable lease payments that depend on an index or rate are Example 3 – Variable lease payments linked to sales
initially included in the lease liability using the index or rate at Assume the same fact pattern as for Example 2 but Entity
the commencement date of the lease. Variable lease payments Q is also required to make variable lease payments equal
include payments linked to a consumer price index, payments to 0.1% of sales generated from the leased property. At
linked to a benchmark interest rate (such as EURIBOR) or commencement, the lease liability is measured at the same
payments that vary to reflect changes in market rental rates. amount as in Example 2. This is because the additional
lease payments, while variable, are linked to future sales
After the commencement date, the lessee increases the rather than an index or rate. As a result, they do not meet
carrying amount to reflect interest on the lease liability the definition of lease payments under Ind AS 116 and are
and reduces the liability for lease payments made. It also not included in the measurement of the lease liability or the
remeasures the carrying amount to reflect changes in the lease right-of-use asset.
payments arising from changes in the index or rate.
During the first year of the lease, the lessee generates
In remeasuring the carrying amount, the lessee uses an sales of INR 800,000. Entity Q incurs an additional expense
unchanged discount rate unless the change in lease payments of INR 800 (INR 800,000 X 0.1%). This is recognised in profit
results from a change in floating interest rates. In that scenario, or loss during the first year.
the lessee shall use a revised discount rate that reflects
changes in the interest rate.

Lease payments 2
 Example 4 – Variable lease payments becoming fixed
Allocation of non-lease components
Entity S enters into a four-year lease for a specialised A contract may include an amount payable by the lessee for
photocopier. The lease payments are INR 500 per month if additional services related to the lease. For example, a contract
the copier is used to produce 100,000 copies or less over for the lease of a building may require the lessee to make
the lease term. If the copier is used to make more than additional payments for maintenance of common areas, or
100,000 copies, then the monthly rental is adjusted to INR for other goods and services it receives. These are considered
700 per month (which is applied from the commencement non-lease components because they provide the lessee with an
of the lease). additional good or service.

The copier exceeds 100,000 copies at the start of year In other cases, a lessee may be required to compensate the
three. At this point, Entity S is required to make a catch-up lessor for activities and tasks that do not provide a good
payment of INR 4,800. The remaining payments are or service to the lessee. Such charges do not give rise to a
adjusted upwards to INR 700 per month. separate component of the contract but are seen to be part
of the total consideration that is allocated to the separately
Analysis identified components of the contract.
In our view, on commencement, the lease liability is
based on lease payments of INR 500 per month. When a contract contains a lease component and one or more
non-lease components, the lessee allocates the consideration
At the start of year three, the catch-up payment is in the contract to each lease component based on the
recorded in profit or loss. The right-of-use asset and relative standalone prices of the lease components and the
lease liability are adjusted for the increase of INR aggregate standalone price of the non-lease components. If a
200 per month for the remaining lease term (on a standalone price is not available then the lessee must estimate
discounted basis). This is because these payments it, maximising the use of observable information.
have become in-substance fixed payments.

Example 6 – Lease and non-lease components

A lessee (Entity U) enters into a five-year lease of
Market rent reviews equipment, with fixed annual payments of INR 6,000. The
contact itemises the payments as follows:
Increases in lease payments resulting from market rent reviews
• Equipment: INR 4,500
are considered to be variable payments based on an index or
• Maintenance: INR 1,250
rate and should therefore be taken into account when assessing
• Administration: INR 250
lease payments and at the commencement of the lease.
What are the relevant lease and non-lease components?
Example 5 – Impact of market rent reviews affecting
optional renewal periods
Analysis
Entity A enters into a three-year lease for a property
Entity U identifies two components: (a) a lease of
with an option to extend for a further three years. As the
equipment and (b) maintenance services. The amount
entity is reasonably certain the option will be exercised,
paid for administrative tasks does not transfer a
the lease term is determined to be six years. The terms of
service and so represents additional consideration
the renewal option specify that a market rent review will
to be allocated between the lease (equipment) and
be performed at the end of year three and the results of
non-lease (maintenance) components. The total
this review will determine the lease payments to be made
consideration of INR 30,000 is allocated between
for years four to six. Lease payments belonging to the
the lease and non-lease components based on their
renewal period will be included when measuring the right-
relative standalone prices (not given). The non-lease
of-use asset and the lease liability at commencement, but
component is accounted for under the relevant
at what amount?
accounting standard.

Analysis
Lease payments subject to future market rent reviews
are considered to be payments based on an index
or a rate and Ind AS 116.27(b) requires Entity A to
measure the right-of-use asset and lease liability at
commencement using the rate in effect on that date.
When the actual rate for years four to six differs on
renewal, the lease liability would be remeasured
at that time to reflect the revised payments. If the
market rent review occurred annually, then the lease
liability would be remeasured each year assuming
the revised rent applied for all remaining years in the
lease term.

Lease payments 3
Practical expedient – Include non-lease
components in the lease accounting
Ind AS 116 provides a practical expedient where the lessee may
elect, by class of asset, not to separate non-lease components.
A lessee making this election accounts for the lease and non-
lease components together, as a single lease component.

While taking advantage of this practical expedient will simplify

the accounting for contracts containing a lease, it will increase
the amount of recognised assets and liabilities and could have
implications for impairment.

Contact us
We hope you find this article helpful in giving you some
details into aspects of Ind AS 116. If you would like to
discuss any of the points raised, please write to us at
[email protected].
Contact us

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Taxing the digital economy 5