CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

IND AS 116- LEASES

OBJECTIVE : The objective of this standard is to ensure that lessees and lessors provide relevant information
in a manner that faithfully represents those transactions. This information gives a basis for users of financial
statements to assess the effect that leases have on the financial position, financial performance and cash flows of
an entity.

SCOPE: Ind AS 116 shall be applied to ALL LEASES, including leases of Right-of-Use (ROU) assets in a sub-lease,
except:

(a) Leases to explore for or use minerals,oil, natural gas and similar non-regenerative resources. (Ind AS 106).
(b) Leases of biological assets held by a lessee (Ind AS 41).
(c) Licences of intellectual property granted by a lessor (Ind AS 115).
(d) Rights held by a lessee under licensing agreements for such items as motion picture films, video recordings,
plays, manuscripts, patents and copyrights (Ind AS 38).

RECOGNITION EXEMPTION:- In addition to above scope exclusions, a lessee can elect not to apply Ind AS 116’s
recognition requirements to:
1. Short-term leases (Lease term of 12 months or less); and
2. Leases for which the underlying asset is of low-value.

If a lessee elects to apply the above recognition exemption, the lessee shall recognise the lease payments associated with
those leases as an expense on either a straight-line basis over the lease term or another systematic basis.

What is lease : A lease is defined as a contract, or part of contract that conveys the right to control the use of an identified asset
for a period of time in exchange for consideration.

Note 1. Meaning of right to control :- To assess whether a contract conveys the right to control the use of an identified
asset for a period of time, an entity shall assess whether, throughout the period of use, the customer has both of the following:
(a) The right to obtain substantially all of the economic benefits from use of the identified asset; and
(b) The right to direct the use of the identified asset.

Note 2:- Ind AS 16 requires lessor and lessee to determine whether a contract is or contains a lease at the inception of the
contract and accounting in the book of lessor and lessee is made on the commencement date of the lease agreement.
Here, A ‘lessee’ is defined as an entity that obtains the right to use an underlying asset for a period of time in
exchange for consideration.

Note 3. Commencement date is the date on which a lessor makes an underlying asset available for use by a lessee.

Identifying and separating lease components of a contract:

Sometimes, there are contracts that contain rights to use multiple assets (for e.g., a building and an equipment,
multiple pieces of equipment, etc.). The right to use each such asset is considered as a ‘separate’ lease
component ONLY IF BOTH the following conditions are satisfied:
 The lessee can benefit from the use of the asset either on its own OR together with other resources that are
readily available to the lessee AND
 The underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying
assets in the contract.

If one or both of these criteria are not met then, the right to use multiple assets is considered a ‘single’ lease
component, i.e., not a ‘separate’ lease component.

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CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Meaning of lease payments: Lease payments are defined as payments made by a lessee to a lessor relating to the
right to use an underlying asset during the lease term, comprising the following:
(a) Fixed payments (including in-substance fixed payments), less any lease incentives,
(b) Variable lease payments that depend on an index or a rate,
(c) The exercise price of a purchase option if the lessee is reasonably certain to exercise that option,
(d) Payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to
terminate the lease
For the lessee, lease payments also include amounts expected to be payable by the lessee under residual value guarantees.
For the lessors, lease payment includes residual value guarantees provided by the lessee,a party related to the lessee or
a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.

Note 1: ‘Fixed payments’ are defined as payments made by a lessee to a lessor for the right to use an
underlying asset during the lease term, excluding variable lease payments.

Note 2: In substance fixed lease payment:- lease payments also include any in-substance fixed lease payments which
are the payments that may, in form, contain variability but that, in substance, are unavoidable.
Question 1. Entity Q enters into a seven-year lease for a piece of machinery. The contract sets out the lease
payments as follows.

– If Q uses the machinery within a given month, then an amount of 2,000 accrues for that month.
– If Q does not use the machinery within a given month, then an amount of 1,000 accrues for that month.
What is considered as fixed lease payment in this case?
Solution: Q considers the contract and notes that although the lease payments contain variability based on usage, and
there is a realistic possibility that Q may not use the machinery in some months, a monthly payment of R s 1,000 is
unavoidable. Accordingly, this is an in-substance fixed payment, and is included in the measurement of the lease
liability.

Note 3. Variable lease payments that depends on an index or rate:- ‘Variable lease payments’ are defined as the
portion of payments made by a lessee to a lessor for the right to use an underlying asset during the lease term that
varies because of changes in facts or circumstances occurring after the commencement date, other than the passage
of time.
These may include, for e.g., payments linked to a consumer price index, payments linked to a benchmark interest rate
(such as R e p o r a t e , London Interbank offered rate i.e. LIBOR or payments that vary to reflect changes in market rental
rates. Such payments are included in the lease payments and are measured using the prevailing index or rate at the
measurement date (i.e. lease commencement date for initial measurement).

Question 2. An entity enters into a 10-year lease of property. The lease payment for the first year is Rs
1,000. The lease payments are linked to the consumer price index (CPI).The CPI at the beginning of the first year
is 100. Lease payments are updated at the end of every second year. At the end of year one, the CPI is 105. At the
end of year two, the CPI is 108. What should be included in lease payments?

Solution: At the lease commencement date, the lease payments are Rs 1,000 per year for 10 years. The entity does
not take into consideration the potential future changes in the index. At the end of year one, the payments have
not changed and hence, the liability is not updated.
At the end of year two, when the lease payments change, the entity updates the remaining eight lease payments to Rs
1,080 per year (i.e., 1,000 / 100 x 108).

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Treatment of Variable lease payments that do not depend on an index or a rate:

Variable lease payments that do not depend on an index or rate and are not, in substance, fixed payment. Examples
may include payments such as those based on performance (for e.g., a percentage of sales) or usage of the underlying
asset (for e.g., the number of hours flown, the number of units produced), are not included as lease payments. Instead,
they are recognised in profit or loss in the period in which the event that triggers the payment occurs (unless they are
included in the carrying amount of another asset in accordance with other Ind AS).
Question 3. Entity A enters into a five-year lease of an office building. The lease payments are Rs 5,00,000 per year
and the contract includes an additional water charge calculated as Rs 0.50 per litre consumed. Payments are due at
the end of year. Explain the treatment of variable payment for water charges as per Ind AS 116.

Solution: At the commencement date, Entity A s h o u l d measure the lease liability as the present value of the
fixed lease payments (i.e. five annual payments of 5,00,000). Entity A should exclude the non-lease component from
its lease liability because they are variable payments that depend on usage. Entity A should recognise the payments
for water – as a variable lease payment – in profit or loss when they are incurred.

Residual value guarantees: ‘Residual value guarantee’ is defined as a guarantee made to a lessor by a party
unrelated to the lessor that the value (or part of the value) of an underlying asset at the end of a lease will be at
least a specified amount.

Residual value guarantee for a lessee:- Lease payments include amounts expected to be payable by the lessee under
residual value guarantees. A lessee may provide a guarantee to the lessor that the value of the underlying asset it
returns to the lessor at the end of the lease will be at least of a specified amount. Such guarantees are
enforceable obligations that the lessee has assumed by entering into the lease agreement.

Note:- A lessee is required to remeasure the lease liability if there is a change in the amounts expected to be payable
under a residual value guarantee.

Question 4. An entity (a lessee) enters into a lease and guarantees that the lessor will realise Rs 20,000 from selling the
asset to another party at the end of the lease. At lease commencement, based on the lessee’s estimate of the residual value
of the underlying asset, the lessee determines that it expects that it will owe Rs 8,000 at the end of the lease. Whether
the lessee should include the said payment of Rs 8,000 as a lease payment?

Solution: The lessee should include the amount of Rs 8,000 as a lease payment because it is expected that it will owe
the same to the lessor under the residual value guarantee.
Residual value guarantee for a lessor: Ind AS 116 requires lessors to include in the lease payments, any residual value
guarantees provided to the lessor by the lessee, a party related to the lessee, or a third party unrelated to the lessor
that is financially` capable of discharging the obligations under the guarantee. This amount included in the lease payments
is different from that for a lessee which only includes the amount expected to be payable by lessee only.

Discount rates : Discount rates are used to determine the present value of the lease payments, which are used to
determine Right of Use asset and Lease liability in case of a lessee and to measure a lessor’s net investment in the lease.

Discount rate for a lessee:-

Lease payments are discounted using the interest rate implicit in the lease (to be calculated from the perspective
of lessor) if that rate can be readily determined. But, if that rate cannot be readily determined then, the lessee
uses the incremental borrowing rate (2nd preference).

Discount rate for a lessor: Lessor to use the interest rate implicit in the lease only.

Lease accounting in the book of lessee:

Initial recognition and measurement: At the commencement date, a lessee shall recognise a ROU Asset and a Lease
Liability.

Ind AS 116 requires lessees to recognise a liability to make lease payments and an asset representing the right to
use the underlying asset (i.e., the ROU Asset) during the lease term for ALL leases (except for short-term leases and
leases of low-value assets, if they choose to apply such exemptions).

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Measurement of lease liability: At the commencement date, a lessee initially measures the Lease Liability
at the present value of the remaining lease payments to be made over the lease term, discounted using the rate
implicit in the lease (or if that rate cannot be readily determined, the lessee’s incremental borrowing rate). Lease
payments used in measuring the lease liability are amounts due to the lessor excluding any payments that a lessee
makes before lease commencement.

Question 5. Entity L enters into a lease for 10 years, with a single lease payment payable at the beginning of
each year. The initial lease payment is Rs 100,000. Lease payments will increase by the rate of LIBOR each year.
At the date of commencement of the lease, LIBOR is 2 per cent.

Assume that the interest rate implicit in the lease is 5 per cent. How lease liability is initially measured?

Solution: In the given case, the lease payments depend on a rate (i.e., LIBOR) and hence is included in measuring
lease liability. As per Ind AS 116, the lease payments should initially be measured using the rate (i.e. LlBOR) as at
the commencement date. LIBOR at that date is 2 per cent; therefore, in measuring the lease liability, it is assumed
that each year the payments will increase by 2 per cent, as follows:
Year Lease Discount factor @ 5% PV of lease payments
Payment
1 1,00,000 1 100,000
2 1,02,000 0.952 97,102
3 1,04,040 0.907 94,364
4 1,06,121 0.864 91,689
5 1,08,243 0.823 89,084
6 1,10,408 0.784 86,560
7 1,12,616 0.746 84,012
8 1,14,869 0.711 81,672
9 1,17,166 0.677 79,321
10 1,19,509 0.645 77,083
8,80,887

Therefore, the lease liability is initially measured at Rs 8,80,887.

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Measurement/ computation of right of use asset (ROU asset):

A lessee initially measures the ROU Asset at COST, which consists of all of the following:

Present value of lease liability

Add: initial direct costs

Add: PV of estimated cost of dismantling, restoration, decommissioning.

Add: any prepaid lease payments.

Less : lease incentive received.

Journal entry in the books of lessee:

ROU Asset Dr

To lease liability ( PV of outstanding lease liability)

To lessor/bank account (any lease payment paid/payable less cash incentive received)

To bank/ account ( initial direct cost incurred, any prepaid lease payment)

To provision for dismantling

Treatment and meaning of Initial direct cost: ‘Initial direct costs’ are defined as the incremental costs of
obtaining a lease that would not have been incurred if the lease had not been obtained, except for such costs
incurred by a manufacturer or dealer lessor in connection with a finance lease.

For lessee :- Ind AS 116 requires lessees to include their initial direct costs in their initial measurement of the right-of-
use asset. Examples of costs included in initial direct costs are.
Commission t o selling agents

Legal fees resulting from the execution of the lease

Lease document preparation costs incurred after the execution of the lease

Certain payments to existing tenants to move out

Consideration paid for a guarantee of a residual asset by an unrelated third party

For lessors, initial direct costs, other than those incurred by manufacturer or dealer lessors, are included in the initial
measurement of the net investment in the lease and reduce the amount of income recognised over the lease term.

Question 6. Entity Y and Entity Z execute a 12-year lease of a railcar with the following terms on
1 January, 2023:

 The lease commencement date is 1 February 2023.

 Entity Y must pay Entity Z the first monthly rental payment of Rs 10,000 upon execution of the lease.
 Entity Z will pay Entity Y Rs 50,000 cash incentive to enter into the lease payable upon lease execution.
Entity Y incurred Rs 1,000 of initial direct costs, which are payable on 1 February 2023. Entity Y calculated the
initial lease liability as the present value of the lease payments discounted a t Rs 8,50,000. How would
Lessee Company measure and record this lease?

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Subsequent Measurement in the book of lessee:

Right-of-use assets (ROU Asset): After the commencement date, the right-of-use asset should be measured
using a cost model, unless it applies the revaluation model as specified under Ind AS 16.

Cost model for right-of-use assets:

To follow the cost model, an entity measures a right-of-use asset at cost less accumulated depreciation
and accumulated impairment losses; and
Adjusted for re-measurements of the lease liability.

Depreciation for right-of-use assets:-

ROU Assets measured under the cost model should be depreciated in accordance with the depreciation
requirements given in lnd AS 16, subject to the following:
- If the lease transfers ownership of the underlying asset to the lessee by the end of the lease term, or if
the cost of the ROU Asset reflects that the lessee will exercise a purchase option, the ROU Asset should
be depreciated from the commencement date to the end of the useful life of the underlying asset;
- otherwise, the right-of-use asset should be depreciated from the commencement date to the earlier of the end
of the useful life of the ROU Asset and the end of the lease term.

Revaluation model for right-of-use assets:

- If right-of-use assets relate to a class of property, plant and equipment to which the lessee applies the
revaluation model in Ind AS 16, a lessee may elect to apply that revaluation model to all of the right-
of-use assets that relate to that class of property, plant and equipment.
- However, if right-of-use assets that meet the definition of investment property under Ind AS 40 “Investment
Property”, then, revaluation model cannot be applied because at present Ind AS 40 “Investment property”
does not permit revaluation model and only cost model is allowed for all investment properties.

Accounting of Lease liability in the book of lessee:

A Lease Liability should be accounted for in a manner similar to other financial liabilities (i.e., on an amortised cost
basis). Consequently, the lease liability is accreted using an amount that produces a constant periodic discount rate on
the remaining balance of the liability (i.e., the discount rate determined at commencement, as long as a reassessment
requiring a change in the discount rate has not been triggered). Lease payments reduce the lease liability when paid.
Thus, after the commencement date, a lessee shall measure the lease liability by:
a. increasing the carrying amount to reflect interest on the lease liability;
b. reducing the carrying amount to reflect the lease payments made; and
c. remeasuring the carrying amount to reflect any reassessment or lease modifications or to reflect revised in-
substance fixed lease payments.
Expense recognition: Lessee recognises the following items in expense for leases:

 Depreciation of the ROU Asset

 Interest expense on the Lease Liability
 Variable lease payments that are not included in the lease liability (for e.g., variable lease
payments that do not depend on an index or rate)

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

 Impairment of the ROU Asset

Question 7. Entity ABC (lessee) enters into a three-year lease of equipment. Entity ABC agrees to make
the following annual payments at the end of each year:

Rs 20,000 in year one

Rs 30,000 in year two

Rs 50,000 in year three.

Assumed a discount rate of 12% (which is Entity ABC’s incremental borrowing rate because the interest rate
implicit in the lease cannot be readily determined). Entity ABC depreciates the ROU Asset on a straight-line basis
over the lease term. How would Entity ABC would account for the said lease under Ind AS 116?

Question 8. COC Ltd enters into a property lease with Entity H. The initial term of the lease is 10 years with a 5- year
renewal option. The economic life of the property is 40 years and the fair value of the leased property is Rs 50 Lacs. COC
Ltd has an option to purchase the property at the end of the lease term for Rs 30 lacs. The first advance annual
payment is Rs 5 lacs with an increase of 3% every year thereafter. The implicit rate of interest is 9.04%. Entity H gives
COC Ltd an incentive of Rs 2 lacs (payable at the beginning of year 2), which is to be used for normal tenant
improvement.

COC Ltd is reasonably certain to exercise that purchase option. How would COC Ltd measure the right-of-use
asset and lease liability at the beginning of lease and also calculate depreciation to be charged each
year?

Impairment of ROU asset: Lessees’ ROU Assets are subject to existing impairment requirements in Ind AS 36
Impairment of Assets. Ind AS 36 requires an impairment indicator analysis at each reporting period. If any indicators
are present, the entity is required to estimate the recoverable amount of the asset (or the cash-generating unit
(CGU) of which the asset is a part). The entity has to recognise an impairment loss if the recoverable amount of the
CGU is less than the carrying amount of the CGU. After an impairment loss is recognised, the adjusted carrying
amount of the ROU Asset would be its new basis for depreciation.
Subsequent reversal of a previously recognised impairment loss needs to be assessed if there is any indication that
an impairment loss recognised in prior periods may no longer exist or may have decreased. In recognising any reversal,
the increased carrying amount of the asset must not exceed the carrying amount that would have been determined
after depreciation, had there been no impairment.

Re-measurement of lease liability: Ind AS 16 requires lessee to remeasure lease liabilities upon a change
in payments on account of any of the following:

(i) the reassessment of lease term on account of reasonable certainty to exercise/ not exercise of extension
and/ or termination option.

(ii) the reassessment of whether the lessee is reasonably certain to exercise an option to purchase the
underlying asset.

(iii) changes in in-substance fixed lease payments.

(iv) the amounts expected to be payable under residual value guarantees.

(v) future lease payments resulting from a change in an index or rate.

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

When to use a ‘revised’ discount rate on re-measurement of lease liability?

Lessees use a revised discount rate when lease payments are updated for
- reassessment of the lease term OR
- a reassessment of a purchase option.
Note:- The revised discount rate is for the REMAINDER of the lease term.

Question 9. Entity W entered into a contract for lease of retail store with Entity J on January 01/01/2021. The initial
term of the lease is 5 years with a renewal option of further 3 years. The annual payments for initial term and
renewal term is Rs 100,000 and Rs 110,000 respectively payable at the beginning of every year. The annual lease
payment will increase based on the annual increase in the CPI at the end of the preceding year.

Entity W’s incremental borrowing rate at the lease inception date and as at 01/01/2024 is 5% and 6% respectively
and the CPI at lease commencement date and as at 01/01/2024 is 120 and 125 respectively.

At the lease commencement date, Entity W did not have a significant economic incentive to exercise the renewal
option. On 1st January 2024, Entity W installed unique lease improvements into the retail store with an estimated
five-year economic life. Entity W determined that it would only recover the cost of the improvements if it exercises
the renewal option, creating a significant economic incentive to extend.

Is Entity W required to remeasure the lease on 1st January 2024? If yes calculate the revised value of ROU asset
and lease liability on the date of remeasurement and also pass journal entry for remeasurement.

Lease modification:
A ‘lease modification’ is a change in the scope of a lease, or the consideration for a lease, that was not part of
the original terms and conditions of the lease (for e.g., adding or terminating the right to use one or more
underlying assets, or extending or shortening the contractual lease term).
The following are examples of lease modifications that may be negotiated after the lease commencement date:
 A lease extension
 Early termination of the lease
 A change in the timing of lease payments
 Leasing additional space in the same building.
 Surrendering a part of the underlying asset.
Lease modification can result in:
 A separate lease OR
 A change in the accounting for the existing lease (i.e., not a separate lease).
NOTE:- The exercise of an existing purchase or renewal option or a change in the assessment of whether such options are
reasonably certain to be exercised are not lease modifications but can result in the remeasurement of Lease Liabilities
and ROU Assets (Remeasurement – as discussed above).

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Modification – Separate lease contract:

A lease modification is accounted for as a separate lease if both criteria are met:
a. The modification increases the scope of the lease by adding the right to use one or more underlying
assets; and
b. The consideration for the lease increases by an amount commensurate with the standalone price
for the increase in scope.
If both criteria are not met, remeasure lease liability and ROU asset.

Question 10. Lessee enters into a 10-year lease for 2,000 square metres of office space. At the beginning of Year
6, Lessee and Lessor agree to amend the original lease for the remaining five years to include an additional 3,000
square metres of office space in the same building. The additional space is made available for use by Lessee at the
end of the second quarter of Year 6. The increase in total consideration for the lease is commensurate with the
current market rate for the new 3,000 square metres of office space. How should the said modification be accounted
for?

Solution: Lessee accounts for the modification as a separate lease, separate from the original 10-year lease because the
modification grants Lessee an additional right to use an underlying asset, and the increase in consideration for the
lease is commensurate with the stand-alone price of the additional right-of-use asset

Accordingly, at the commencement date of the new lease (at the end of the second quarter of Year 6), Lessee
recognises a ROU Asset and a lease liability relating to the lease of the additional 3,000 square metres of office space.

Question 11.( Modification that increases the scope of the lease by extending the contractual lease term): Lessee
enters into a 10-year lease for 5,000 square metres of office space. The annual lease payments are Rs 1,00,000 payable
at the end of each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental
borrowing rate at the commencement date is 6% p.a. At the beginning of Year 7, Lessee and Lessor agree to amend
the original lease by extending the contractual lease term by four years. The annual lease payments are unchanged
(i.e., Rs 1,00,000 payable at the end of each year from Year 7 to Year 14). Lessee’s incremental borrowing rate at the
beginning of Year 7 is 7% p.a.

How should the said modification be accounted for?

Solution: 1. Calculation of Lease liability as at commencement date:

Year Lease Payment Present value factor @ 6% (B) Present value of
(A) lease payments
(A x B = C)
1 100,000 0.943 94,300
2 100,000 0.890 89,000
3 100,000 0.840 84,000
4 100,000 0.792 79,200
5 100,000 0.747 74,700
6 100,000 0.705 70,500
7 100,000 0.665 66,500
8 100,000 0.627 62,700
9 100,000 0.592 59,200
10 100,000 0.558 55,800
Lease liability as at commencement date 7,35,900

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

2. Calculation of Lease liability immediately before modification date:

Year Opening lease Interest @ 6% Lease payments Closing liability
liability (A) (B) = [A x 6%] (C) (D) = [A+B-C]

1 7,35,900 44,154 100,000 6,80,054

2 6,80,054 40,803 100,000 6,20,857
3 6,20,857 37,251 100,000 5,58,108
4 5,58,108 33,486 100,000 4,91,594
5 4,91,594 29,496 100,000 4,21,090
6 4,21,090 25,265 100,000 3,46,355
Lease liability as at modification date 3,46,355

3. Calculation of modified lease liability:

Year Lease Payment(A) Present value factor@ 7% (B) Present value of lease
payments (A*B=C)
7 100,000 0.935 93,500
8 100,000 0.873 87,300
9 100,000 0.816 81,600
10 100,000 0.763 76,300
11 100,000 0.713 71,300
12 100,000 0.666 66,600
13 100,000 0.623 62,300
14 100,000 0.582 58,200
Modified lease liability 5,97,100

Adjustment to ROU asset:

Modified Lease liability 5,97,100

Original Lease liability as at modification date (3,46,355)

Adjustment to ROU asset 2,50,745

The ROU asset will be increased by Rs 2,50,745 on the date of modification.

Question 12 (Modification that decreases the scope of the lease) Lessee enters into a 10-year lease for 5,000
square metres of office space. The annual lease payments are Rs 50,000 payable at the end of each year. The interest
rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the commencement
date is 6% p.a. At the beginning of Year 6, Lessee and Lessor agree to amend the original lease to reduce the space
to only 2,500 square metres of the original space starting from the end of the first quarter of Year 6. The annual
fixed lease payments (from Year 6 to Year 10) are Rs 30,000. Lessee’s incremental borrowing rate at the beginning
of Year 6 is 5% p.a. How should the said modification be accounted for?

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Solution: 1. Calculation of Initial value of ROU asset and lease liability:

Year Lease Present value Present value of lease

Payment(A) factor @ 6% (B) payments (A x B = C)
1 50,000 0.943 47,150
2 50,000 0.890 44,500
3 50,000 0.840 42,000
4 50,000 0.792 39,600
5 50,000 0.747 37,350
6 50,000 0.705 35,250
7 50,000 0.665 33,250
8 50,000 0.627 31,350
9 50,000 0.592 29,600
10 50,000 0.558 27,900
3,67,950

2. calculation of the lease liabilities before modification as follows:

Lease Liability
Year Initial value Lease payments Interest expense @ 6% Closing balance

a B c = a x 6% d = a-b +c
1 3,67,950 50,000 22,077 3,40,027
2 3,40,027 50,000 20,402 3,10,429
3 3,10,429 50,000 18,626 2,79,055
4 2,79,055 50,000 16,743 2,45,798
5 2,45,798 50,000 14,748 2,10,546
6 2,10,546

3. Carrying amount of ROU asset on the date of modification:

3,67,950
3,67,950 – ( 𝑋 5) = 1,83,975
10

At the effective date of the modification (at the beginning of Year 6), Lessee re-measures the lease liability based on:
(a) a five-year remaining lease term,
(b) annual payments of Rs 30,000 and
(c) Lessee’s incremental borrowing rate of 5% p.a.
Year Lease Payment(A) Present value Present value of lease
factor @ 5% (B) payments (A x B = C)
6 30,000 0.952 28,560
7 30,000 0.907 27,210
8 30,000 0.864 25,920
9 30,000 0.823 24,690
10 30,000 0.784 23,520
Total 1,29,900

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Lessee will determine the proportionate decrease in the carrying amount of the ROU asset on the basis of the remaining
ROU Asset (i.e., 2,500 square metres corresponding to 50% of the original ROU Asset).
50% of the pre-modification ROU Asset ( Rs 1,83,975) is R s 91,987.50.

50% of the pre-modification lease liability ( Rs 2,10,546) is Rs 1,05,273.

Consequently, Lessee will reduce the carrying amount of the ROU Asset by 91,987.50 and the carrying amount of the lease
liability by 1,05,273.

Lessee w i l l recognise the difference between the decrease in the lease liability and the decrease in the ROU Asset
(1,05,273 – 91,987.50 = 13,285.50) as a gain in profit or loss at the effective date of the modification (at the beginning of
Year 6).
Lessee will recognise the difference between the remaining lease liability of 1,05,273 and the modified lease liability of
1,29,900 (which equals 24,627) as an adjustment to the ROU Asset reflecting the change in the consideration paid for the
lease and the revised discount rate.
Presentation of items related to ROU asset and lease liability in financial statement:

Balance Sheet Statement of profit andloss Statement of cash flows

ROU Assets: Depreciation and Interest: Principal portion of the lease

They are presented either: Depreciation on Right of use asset liability:
and interest expense - These cash payments are
- Separately from other assets accreted on lease liabilities presented within financing
are presented separately (i.e., they activities
OR CANNOT be combined).

This is because interest expense on

- Together with other assetsas if they the lease liability is a component of Interest portion of the lease
were owned, with disclosures of finance costs liability:
the balance sheet line items that - These cash payments are
include ROU Assets and their presented within financing
amounts activities

- ROU Assets that meet the Short-term leases and leases of

definition of investment property low-value assets:
are presented as investment - Lease payments pertaining to
property them (i.e., not recognised on the
balance sheet as per Ind AS 116)
Lease Liabilities: are presented within operating
They are presented either: activities
- Separately from other liabilities
OR Variable lease payments not
- Together with other liabilities included in the lease liability:
with disclosure of the balance - These are also presented
sheet line items that includes within operating activities
lease liabilities and their
amounts

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Accounting in the book of lessor:

Lessor:- A ‘lessor’ is defined as an entity that provides the right to use an underlying asset for a period of time
in exchange for consideration.
At inception of lease, lessors classify all leases as FINANCE LEASE or OPERATING LEASE.
Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form of the contract.
(a) Finance lease:- a ‘Finance Lease’ is defined as a lease that transfers substantially all the risks and rewards incidental
to ownership of an underlying asset.

Ind AS 116 lists a number of examples that individually, or in combination, would normally lead to a lease being classified
as a finance lease:
(a) the lease transfers ownership of the underlying asset to the lessee by the end of the lease term;
(b) the lessee has the option to purchase the underlying asset at a price that is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable;
(c) the lease term is for the major part of the economic life of the underlying asset even if title is not
transferred;
(d) at the inception date, the present value of the lease payments amounts to at least substantially all
of the fair value of the underlying asset; and
(e) the underlying asset is of such a specialised nature that only the lessee can use it without major
modifications.

Recognition of finance lease:- At the commencement date, a lessor shall recognise assets held under a finance
lease in its balance sheet and present them as a receivable at an amount equal to the net investment in the lease.

For finance leases (other than those involving manufacturer and dealer lessors), initial direct costs are included in the
initial measurement of the finance lease receivable.
(b) Operating lease:- an ‘Operating Lease’ is defined as a lease that does not transfer substantially all the risks
and rewards incidental to ownership of an underlying asset.
Accounting of operating lease in the book of lessor:

- lessor shall recognise lease income on SLM basis over the lease term.
- Lessor shall continue to recognise respective asset in his books of account and charge depreciation
on it.
- Journal entries at the year end in the book of lessor:-
(a) When given on lease: no entry
(b) At the year end:-

(i) bank account Dr

To lease income

(ii) depreciation account Dr

To asset account

(iii) profit and loss account Dr

To depreciation account

(iv) lease income account Dr

To profit & loss account

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Accounting of finance lease in the book of lessor:

(i) Lessor shall initially do the following on commencement date:

- Derecognise the asset under lease at carrying amount.

- Recognise lease receivable (asset) at the amount equal to net investment in lease.
- Balancing figure (if any) will be recognised as profit or loss.
Journal entry at the commencement date:

Debit Credit
Lease receivable account Dr Net investment
Loss on sale(SPL) Dr
To asset account Carrying amount
To gain on sale (SPL)

(ii) no depreciation will be charged by the lessor on this asset in future.

(iii) interest income (finance income) is booked over the lease term on lease receivable to unwind
the discount.

(iv) Journal entry at the end of year:

(a) for unwinding discount on lease receivable:

Lease receivable account Dr
To finance income (SPL)
(b) for receipt of lease instalment:
Bank account Dr
To lease receivable
Note:

(i) Gross investment in lease = total lease payment by the lessee + unguaranteed residual value.

(ii) Net investment in lease = PV of Gross investment in lease (Using lessor’s implicit rate of return) less
deferred selling profit(as per ICMAI Study material only).

Note:- Deferred selling profit is calculated as the lease receivable less the carrying amount of the
underlying asset, net of unguaranteed residual.
(iii) unguaranteed residual value = total expected residual value by the lessor – GRV by the lessee.

(iv) unearned finance income = Gross investment – net investment in lease.

(v) Interest income includes interest on the lease receivable, accretion of the unguaranteed residual
value and amortisation of deferred selling profit. The rate for recognising interest income to produce a
constant periodic rate of return on the remaining net investment is IRR.

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Question 13. COC Ltd given his building on finance lease for the period of 3 years on annual lease
payment of Rs 1,00,000 at the end of one year. Guaranteed residual value by the lessee is Rs 20,000.
Expected unguaranteed residual value is Rs 30,000. Discounting rate is 10%. Carrying amount of building
in the book of COC Ltd is Rs 2,50,000. Pass journal entries for the first year of lease. Also calculate
Unearned finance income.
Solution: PV of lease receivable Rs 2,63,620; PV of UGRV Rs 22,530; Net investment Rs 2,86,150;

Finance income on lease receivable 1st year- Rs 28,615; 2nd year- Rs 21,477; 3rd year- Rs 13,758.

Unearned finance income Rs 63,850.

Accounting of finance income in the book of dealer lessor:

Dealer lessor will also recognise sales and cost of goods sold (COGS) in his journal entry along with
recognition of lease receivable and derecognition of asset.

Journal entry on lease commencement date in the book of lessor:

Debit Credit
Lease receivable account Dr (Net investment)
COGS account Dr CA of asset- PV of UGRV
To asset account Carrying amount(CA)
To sales account NI - PV of UGRV
Note: balancing figure will be the gain/loss in lease.

Question 14. A Dealer-Lessor enters into a 10-year lease of equipment with Lessee. The equipment is not specialised in
nature and is expected to have alternative use to Lessor at the end of the 10-year lease term. Under the lease:

 Lessor receives annual lease payments of Rs 15,000, payable at the end of the year.
 Lessor expects the residual value of the equipment to be Rs 50,000 at the end of the 10-year lease term
 Lessee provides a residual value guarantee that protects Lessor from the first Rs 30,000 of loss for a sale at a
price below the estimated residual value at the end of the lease term (i.e., Rs 50,000)
 The equipment has an estimated remaining economic life of 15 years, a carrying amount of Rs 1,00,000 and a
fair value of Rs 1,11,000.
 The lease does not transfer ownership of the underlying asset to Lessee at the end of the lease term or contain
an option to purchase the underlying asset
 The interest rate implicit in the lease is 10.078%.
How should the Lessor account for the same in its books of accounts?
Answer :

Net investment in the lease Dr. 1,11,000

Cost of goods sold Dr. 92,340
To Revenue 1,03,340
To Property held for lease 1,00,000

Interest income recognised in first year Rs 11,187.

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Disclosure in the book of lessor: The objective of the disclosures is for lessors to disclose information in
the notes that, together with the information provided in the balance sheet, statement of profit or loss and
statement of cash flows, gives a basis forusers of financial statements to assess the effect that leases have on
the financial position, financial performance and cash flows of the lessor.

A lessor shall disclose the following amounts for the reporting period:
(a) for finance leases: (i) selling profit or loss; (ii) finance income on the net investment in the
lease; and (iii) income relating to variable lease payments not included in the measurement of
the net investment in the lease.
(b) for operating leases: lease income, separately disclosing income relating to variable lease
payments that do not depend on an index or a rate.
Concept of deferred selling profit (exception to above treatment in the book of lessor):

Question 15. Lessor Y leases out an equipment (carrying amount Rs 1,36,000 having 5 years life) to
Lessee X for 3 years for annual payment of Rs 50,000 (at the end of every year) and residual value of Rs
50,000, guaranteed by X up to loss of Rs 30,000. Interest rate implicit is 10%. At the end of the lease the
equipment is valued at Rs 33,000. Show accounting in books of X and Y. Show accounting of lease
classified as finance lease in books of Y. The rate of interest income on the net investment in lease,
however, is 19.274%. (ICMAI Study material)

Solution: Accounting in books of Lessee X:

At 10% implicit rate of interest the (Right-of-use) ROU Asset and Lease Liability are initially recognisedat
present value of payments as shown below.

Year Payments (`) Disc. Factor DCF at 10% (`)

1 50,000 0.90909091 45,454.55

2 50,000 0.82644628 41,322.31

3 50,000 0.7513148 37,565.74

3 Guaranteed 30,000 0.7513148 22,539.44

Present value 1,46,882

Statement showing computation of Lease Liability repayment and interest:

Year Interest Payment/ remission Balance

0 1,46,882
1 14,688.2 50,000 1,11,570.2
2 11,157.02 50,000 72,727.27
3 7,272.727 50,000 30,000
3 0 17,000 guarantee payments (50,000 – 33,000) 13,000
3 0 13,000 guarantee remissions (30,000 – 17,000) 0

ROU asset depreciation during lease period by SLM Method:

Year Depreciation Balance

0 1,46,882
1 48,961 97,921
2 48,961 48,960
3 48,960 0

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

 CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Journal entries in the book of lessee:

Particula (`) (`)

rs
At inception ROU Asset A/c Dr. 1,46,882
1,46,882
To, Lease Liability A/c

At the end Interest Expenses A/c Dr. 14,688

ofYear 1 14,688
To, Lease Liability A/c

Lease Liability A/c Dr. 50,000

50,000
To, Bank A/c

Depreciation A/c Dr 48,961

To, ROU Asset 48,961

At the end of Interest Expenses A/c 11,157

Year 2 To, Lease Liability A/c 11,157

Lease Liability A/c 50,000

To, Bank A/c 50,000

Depreciation A/c 48,961

To, ROU Asset 48,961

At the end of Interest Expenses A/c 7,273

Year 3 To, Lease Liability A/c 7,273

Lease Liability A/c 50,000

To, Bank A/c 50,000

Depreciation A/c 48,960

To, ROU Asset A/c 48,960

Lease Liability A/c Dr. 30,000

17,000
To, Bank A/c
(50,000 – 33,000 = 17,000, guaranteed up to 30,000)
To, P&L (liability remission) ## 13,000

## if during lease any increase or decrease in liability arises when there exists a balance
in ROU, to that extent ROU will be debited/credited instead of P&L.

Accounting treatment in the book of Y (Lessor):

(a) present value of lease receivable = Rs 1,46,882 (calculated as above)
(b) Deferred selling profits at inception:
Revenue = Present value of lease receivable 1,46,882
Cost of goods sold
1,20,974
= 136000 – 15026 (Carrying amount - Present Value of Unguaranteed residual*)

Deferred selling profits at inception 25,908

*Rs 20,000 × 0.7513 = Rs 15,026

(c) Net Investment in Lease at inception = Present value of lease receivable + P. V. of Unguaranteed residual –
Deferred selling profits = 1,46,882 + 15,026 – 25,908 = Rs 1,36,000 = Carrying amount of the underlying asset.
(d) Interest income on net investment in lease (19.274%) includes interest on the lease receivable, accretion of
the unguaranteed residual value and amortisation of deferred selling profit.

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142

CMA FINAL-CFR Ind AS 116 CMA Santosh kumar

Net Investment in Lease 1,36,000

Add Interest Income @ 19.274% = 1,36,000 × 19.274% 26,213
Total 1,62,213
Less Payment 50,000
Balance at the end of year 1 1,12,213
Add Interest Income @ 19.274% = 1,12,213 × 19.274% 21,628
Total 1,33,841
Less Payment 50,000
Balance at the end of year 2 83,841
Add Interest Income @ 19.274% = `83,841 × 19.274% 16,159
Total 1,00,000
Less Payment 50,000
Less Payment for Guaranteed loss borne by Lessee 17,000
Returned at residual value at the end of year 3 33,000

JOURNAL ENTRIES IN THE BOOK OF LESSOR

At the Net Investment in Lease A/c 1,36,000
1,36,000
Inception To, PPE
At the end Bank A/c Dr. 50,000
of year 1 To, Interest Income A/c 26,213
To, Net Investment in Lease A/c [50,000 – 26,213] 23,787

At the Bank A/c Dr. 50,000

end of To, Interest Income A/c 21,628
year 2 To, Net Investment in Lease A/c 28,372

At the end Bank A/c Dr. 50,000

of year 3 To, Interest Income A/c 16,159
To, Net Investment in Lease A/c 33,841

PPE A/c Dr. 33,000

Bank A/c Dr.# 17,000
To, Net Investment in Lease A/c 50,000

# Residual Value = 33,000. Loss = 50,000 – 33,000 = 17,000 borne by lessee (guaranteed by lessee up to Rs 30000)

COCEDUCATION.COM Enquiry No- 9999631597, 7303445575, 8448322142