Lease accounting in India is governed by Ind AS 116, issued by the Institute of Chartered Accountants of India and notified by the Ministry of Corporate Affairs, requiring most lease arrangements to be recorded as both a right-of-use asset and a lease liability. This ensures lease obligations and asset usage are clearly reflected in financial statements, improving transparency, financial control and decision-making.
The standard has been effective from 1 April 2019 and applies to companies under the Ind AS framework, including listed entities, large unlisted companies and select NBFCs.
What does lease accounting mean for Indian businesses?
In practical terms, lease accounting is not just about recording rent expenses. It ensures that:
- The asset being used (such as office space, machinery or vehicles) is recognised
- The future payment obligation is reflected in financial statements
- Financial reports show the true cost of using leased assets
- Lease-related risks and long-term commitments are transparently disclosed
This is especially important for businesses with long-term leases, where payments extend over several years.
Ind AS 116 vs AS 19
Understanding which standard applies is important before applying lease accounting:
- Ind AS 116 (Ind AS companies): Applies to listed companies and large entities covered under the Ministry of Corporate Affairs (MCA) roadmap. These businesses must recognise most leases on the balance sheet. Ind AS 116 was notified by the MCA and became effective from 1 April 2019. It follows a single model under which most leases are recognised as assets and liabilities.
- AS 19 (non-Ind AS entities): Applies to many SMEs and smaller businesses. Here, leases are still classified as operating or finance leases, with different accounting treatment. AS 19 follows a dual classification model, treating operating and finance leases differently, which may keep some leases off the balance sheet.
However, it is important to note that the single-model approach under Ind AS 116 applies only to lessees. Lessors continue to follow a dual classification approach similar to AS 19.
Key components of lease accounting
Understanding these components is essential for applying lease accounting correctly.
- Right-of-use (ROU) asset: Represents the business’s right to use the leased asset over the lease term.
- Lease liability: Represents the present value of future lease payments the business must make.
- Lease payments: Includes fixed payments, variable payments linked to an index or rate, residual value guarantees and payments for purchase options if reasonably certain.
- Lease term: The duration over which the asset will be used, including renewal options if reasonably certain.
Key requirement under Ind AS 116
The biggest change is how leases are recorded. Make sure to:
- Recognise lease asset: Record the right to use the asset so financial statements reflect actual asset usage, not just ownership.
- Record lease liability: Show the present value of future payments upfront to reflect long-term financial obligations.
- Apply one model: Use a single accounting approach for most leases, avoiding earlier classification complexity.
- Use an appropriate discount rate (incremental borrowing rate or implicit rate): To measure lease liability.
Initial measurement of lease components
A critical requirement under Ind AS 116 is the correct measurement of lease liability and ROU asset at the start of the lease.
- Lease liability is measured as the present value of future lease payments, discounted using the incremental borrowing rate (IBR) or the interest rate implicit in the lease (if readily available).
- ROU assets include the lease liability, initial direct costs, fees, prepaid lease payments and estimated restoration costs (if applicable).
How lease accounting impacts financial statements
Lease accounting directly changes how your financials look and are interpreted.
- Balance sheet expansion: Assets and liabilities increase, giving a clearer view of commitments.
- Expense split: Lease cost is split into depreciation and interest rather than a single rent expense.
- Ratio changes: Debt and return ratios shift, affecting how performance is evaluated.
- Cash flow clarity: Payments are separated into operating and financing components.
- Impact on EBITDA: EBITDA typically increases because rent expense is replaced by depreciation and interest, which are excluded from the EBITDA calculation.
Practical steps to apply lease accounting
Applying lease accounting under Ind AS 116 requires a structured and consistent process to ensure accurate reporting.
- Identify all leases: Review agreements carefully, including service contracts that may contain lease elements.
- Check asset control: Confirm the contract gives control over a specific asset for a defined period.
- Measure liability: Discount future payments to calculate the lease liability at the start.
- Record ROU asset: Recognise the asset based on liability and initial costs.
- Track periodically: Record depreciation and interest separately over the lease term.
Exemptions under Ind AS 116
Not all leases need full recognition. Common exemptions include:
- Short-term leases: Leases up to 12 months can be treated as expenses to simplify accounting.
- Low-value assets: Small-ticket items may not need capitalisation, reducing reporting complexity.
Note: Ind AS does not prescribe a strict monetary threshold for low-value assets, but entities often rely on international guidance for interpretation.
Challenges businesses face with lease accounting
Most issues arise during implementation and ongoing tracking, including:
- Hidden lease terms: Some contracts include lease components that are easy to overlook.
- Wrong discount rate: Incorrect rates can distort liability and expense calculations.
- Manual tracking issues: Multiple leases increase the risk of errors when systems are not in place.
- Missed updates: Lease term changes are not always reflected in the records.
- Audit scrutiny: Regulators and auditors closely review assumptions like discount rates and lease terms.
Using systems to manage lease accounting
As lease volume grows, manual tracking becomes inefficient. Systems should enable:
- Centralised tracking of lease agreements
- Automated calculation of liabilities and depreciation
- Real-time visibility into lease obligations
- Accurate reporting aligned with Ind AS requirements
Having structured financial data makes it easier to manage lease accounting alongside overall business reporting.
Conclusion
Lease accounting under Ind AS 116 shifts financial reporting from recording simple lease payments to reflecting the true financial impact of lease arrangements. This provides greater transparency by clearly presenting both liabilities and asset usage in the financial statements, helping businesses better understand their real commitments.
For growing businesses, accurate lease tracking is essential for compliance, better financial control and informed decision-making around long-term costs. Tools like TallyPrime support this by organising financial data in a structured way, making it easier to track lease obligations, maintain Ind AS compliance and manage reporting with greater confidence and clarity.
