Understanding IFRS 16 and Ind AS 116 in India

As India’s financial reporting landscape continues to align with global standards, understanding IFRS 16 and its applicability in India is essential for businesses. IFRS 16, the international standard for lease accounting, has been a game changer globally, and in India, its equivalent is Ind AS 116. For businesses operating in India, particularly those with leasing as a significant part of their operations, it’s crucial to know how these standards impact financial reporting.

In this guide, we explore the applicability of IFRS 16 in India, its alignment with Indian Accounting Standards (Ind AS 116), and the practical implications for Indian companies.

What is IFRS 16?

IFRS 16 is a global accounting standard introduced by the International Accounting Standards Board (IASB). It focuses on how leases are accounted for in financial statements. Under IFRS 16, companies must recognize right-of-use assets and lease liabilities for nearly all leases, requiring leases to be reflected on the balance sheet. This change increases transparency and ensures that financial statements offer a more accurate view of a company’s financial position.

Before IFRS 16, operating leases were treated as off-balance-sheet items, which often understated a company’s liabilities. Now, both the asset and the liability associated with a lease must be recorded, providing a more transparent representation of lease-related obligations.

IFRS 16 vs. Ind AS 116: The Indian Context

In India, the Ministry of Corporate Affairs (MCA) has adopted Ind AS 116 (Leases), which is almost identical to IFRS 16. Ind AS 116, which came into effect on April 1, 2019, governs lease accounting for Indian companies and mirrors the key principles of IFRS 16.

Applicability of Ind AS 116 in India

Ind AS 116 applies to the following types of companies:

• Listed companies in India.
• Unlisted companies with a net worth of INR 250 crore or more.
• Holding, subsidiary, joint venture, and associate companies of those meeting the criteria above.

For these companies, Ind AS 116 replaces the earlier standard, Ind AS 17, aligning India’s accounting standards with IFRS 16 and introducing significant changes to how leases are recorded in financial statements.

Key Features of Ind AS 116 (Similar to IFRS 16)

1. Lease Recognition on Balance Sheet: Under Ind AS 116, businesses must record right-of-use assets and lease liabilities for most leases on their balance sheets. This includes leases that were previously classified as operating leases and kept off the balance sheet, except for short-term leases and low-value assets.
2. Right-of-Use Asset: The right-of-use asset is recognized at the lease commencement date and reflects the company’s right to use the leased asset during the lease term. The value of this asset includes the present value of future lease payments, along with any initial direct costs.
3. Lease Liability: The lease liability represents the present value of future lease payments, discounted at the interest rate implicit in the lease or the company’s incremental borrowing rate. This liability is recorded on the balance sheet and is reduced as lease payments are made.
4. Impact on Income Statement: Lease-related expenses are treated differently under Ind AS 116. Instead of recognizing lease payments as operating expenses, companies must now account for depreciation on the right-of-use asset and interest expense on the lease liability. This change has a direct impact on financial metrics, such as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), which typically increases under Ind AS 116.
5. Exemptions for Short-Term and Low-Value Leases: Ind AS 116 allows businesses to exclude short-term leases (leases of 12 months or less) and low-value asset leases (such as laptops or office furniture) from balance sheet reporting.

Implications for Indian Businesses

The adoption of Ind AS 116 (aligned with IFRS 16) has a significant impact on Indian businesses, especially those that have large lease portfolios.

1. Greater Transparency: The shift to recognizing leases on the balance sheet improves the transparency of financial statements. Investors and stakeholders gain a clearer understanding of a company’s financial commitments and lease obligations.
2. Impact on Key Financial Ratios: Lease liabilities now appear on the balance sheet, which affects debt-to-equity ratios and other financial metrics. Companies may need to reassess these ratios, especially when negotiating financing or meeting loan covenants.
3. Operational Challenges: Implementing Ind AS 116 requires changes in accounting processes, particularly for companies with extensive leasing arrangements. Accurate record-keeping of leases and updated accounting systems are essential to ensure compliance with the new standard.
4. Tax Implications: The shift in lease accounting can affect how lease payments are treated for tax purposes, including direct and indirect tax considerations. Businesses should seek advice from tax professionals to navigate these complexities.

How Indian Companies Can Prepare for Ind AS 116

Implementing Ind AS 116 successfully requires a well-planned approach. Here are the steps Indian businesses should take:

1. Review Existing Lease Agreements: Businesses should review their existing leases to identify any changes needed under the new standard. This includes ensuring accurate classification and measurement of all lease-related assets and liabilities.
2. Evaluate the Financial Impact: Companies need to assess how the adoption of Ind AS 116 will impact key financial metrics, such as EBITDA, debt ratios, and profitability. Conducting an impact analysis can help businesses anticipate these changes.
3. Upgrade Accounting Systems: Many companies will need to upgrade their accounting systems to handle the more complex lease accounting requirements. Specialized lease accounting software can help streamline compliance with Ind AS 116.
4. Train Financial Staff: Ensuring that financial and accounting teams are well-versed in Ind AS 116 is crucial for ongoing compliance. Proper training will help avoid errors in reporting and ensure a smooth transition to the new standard.

Conclusion

Ind AS 116, aligned with IFRS 16, marks a significant shift in how Indian businesses account for leases. By bringing lease liabilities onto the balance sheet, the standard enhances transparency and provides stakeholders with a more accurate view of a company’s financial commitments. While the transition to Ind AS 116 may require adjustments in accounting systems and processes, understanding and complying with the new standard is essential for businesses that want to ensure accurate financial reporting and maintain investor confidence.

For companies looking for a smoother transition, working with accounting professionals or adopting lease accounting software can greatly simplify the process and ensure compliance with Ind AS 116. Read on the official guidance to learn more.