Lease accounting changed completely when IND AS 116 replaced the old standard. Earlier,
companies were allowed to keep several lease arrangements off the balance sheet and recognize only the
rent expense in the Profit & Loss account. This meant that large obligations were hidden from investors
and lenders. Under the IND
AS 116, nearly all leases come on the balance sheet. That is why understanding this
standard is not just important for exams but also for interviews and real-world finance roles.
If you are a CA Inter student or a fresher preparing for audits, financial reporting, or corporate
finance roles, you cannot ignore this standard. In this guide, we will break down the logic,
calculations, journal entries, and practical application in simple language so that you understand the
concept and not just memorize entries.
What is IND AS 116?
IND AS 116 lease accounting is the accounting standard that deals with how companies
should record leases in their financial statements. It was introduced to bring transparency and ensure
that lease obligations are properly reflected on the balance sheet instead of being kept off it.
In simple words, if a company is using an asset for a long period and is committed to making regular
payments, it cannot treat it as a simple rent expense anymore. It must recognize both an asset and a
liability in its books.
Why did it replace IND AS 17?
Under IND AS 17, leases were classified into finance leases and operating leases. Finance leases
were shown on the balance sheet, but operating leases were not. For operating leases, companies used
to recognize rent expense only in the Profit & Loss account.
This created several problems. Liabilities were hidden from users of financial statements. Financial
ratios such as debt-equity ratio were distorted. Investors and lenders could not see the real
financial commitments of a company.
To solve this issue, IND AS 116 leases removed the operating lease classification
for lessees and
introduced a single accounting model. Now, most leases are capitalized.
Why did the operating lease concept change?
Earlier, an operating lease meant rent expense, no asset, and no liability. It looked simple but did
not show the economic reality.
Now, companies must recognize a Right-of-Use asset and a Lease Liability. This ensures transparency
and better comparability across companies.
Applicability of IND AS 116
Understanding the applicability of IND AS 116 is very important both for exams and practical
implementation.
Who must follow it?
This standard applies to all companies that follow the Ind AS framework. This includes listed
companies and certain unlisted companies that meet prescribed thresholds. The Ministry of Corporate
Affairs issued notification regarding IND AS 116 MCA implementation, and it became applicable from 1
April 2019.
Therefore, if a company is required to follow Ind AS, it must apply this lease standard.
Exemptions under IND AS 116
Although the standard is strict, it provides two important practical exemptions. Companies are
allowed not to apply full lease accounting in the case of short-term leases, which are leases of 12
months or less, and leases of low-value assets such as small office equipment.
In such cases, companies can continue to treat payments as rent expense. However, this exemption is
optional and must be applied consistently.
IND AS 116 Leases – Core Concepts
Before jumping into journal entries, you must understand the building blocks of lease accounting. Once
you understand the logic, the numbers become much easier.
Right-of-Use (ROU) Asset
The Right-of-Use asset reflects the lessee’s right to use the underlying asset over the lease
period. For example, if you lease a building for five years, you do not own it, but you have the
right to use it, and that right becomes an asset in your books.
Lease Liability
The lease liability represents the present value of further lease payments. It is similar to a loan
liability because the company has an obligation to pay over time.
Present Value Concept
The present value concept means that money today is worth more than the same amount in the
future
because today’s money can earn interest. So, when we have to pay or receive money in the future, we
convert it into today’s value. This process is called discounting.
The basic formula is:
PV=FV/(1+r)^n
Where:
PV = Present Value
FV = Future Value
r = Discount rate
n = Number of periods
In lease accounting, future lease payments are discounted using this formula, and the total present
value becomes the lease liability recorded in the books.
Discount Rate
The discount rate used is either the rate implicit in the lease or the incremental borrowing rate of
the lessee. In exams, the rate is usually given directly.
Lease Term
The lease term includes the non-cancellable period and any extension period if the lessee is
reasonably certain to exercise the extension option. This directly affects the total liability
calculation.
IND AS 116 Lease Accounting – Step-by-Step
Now, let us understand the overall model of IND
AS 116 lease accounting.
Under this model, at the commencement date, the company recognizes a lease liability and a corresponding
Right-of-Use asset. Over the lease period, the ROU asset is depreciated, and interest is recognized on
the lease liability.
Initial Recognition
At the start of the lease, the entry passed is:
Dr Right-of-Use Asset
Cr Lease Liability
Both are measured at the present value of lease payments.
Measurement of Lease Liability
The lease liability is calculated as the present value of further lease payments. These payments
include fixed payments, in-substance fixed payments, and amounts expected under residual value
guarantees.
ROU Asset Measurement
The ROU asset includes the initial lease liability, any initial direct costs, dismantling costs if
applicable, and is reduced by any lease incentives received.
Subsequent Measurement
After initial recognition, the lease liability increases by interest and decreases when payments are
made. The right-of-use asset is depreciated systematically over the lease term.
Depreciation and Interest
Two expenses appear in the Profit & Loss account. One is depreciation on the ROU asset, and the
other is finance cost representing interest on the lease liability. This leads to a different
expense pattern compared to earlier operating lease accounting.
Re-measurement Cases
Lease liability must be re-measured if there is a change in lease term, change in future payments,
or changes due to index or rate. This area is frequently tested in exams.
Practical Application of IND AS 116
Let us now understand a full numerical example under IND AS 116 leases.
Assume the lease term is 3 years. The annual payment is ₹1,00,000, payable at year-end. The discount
rate is 10%.
Step 1: Present Value Calculation
PV=100000/(1.1)^1+100000/(1.1)^2+100000/(1.1)^3
The approximate present value comes to ₹2,48,685.
Therefore, Lease Liability = ₹2,48,685 and ROU Asset = ₹2,48,685.
Journal Entry at Inception
Dr ROU Asset 2,48,685
Cr Lease Liability 2,48,685
Year 1 Interest
Interest for Year 1 is 10% of ₹2,48,685, which equals ₹24,869.
The journal entry is:
Dr Finance Cost 24,869
Cr Lease Liability 24,869
When payment of ₹1,00,000 is made:
Dr Lease Liability 1,00,000
Cr Bank 1,00,000
The closing lease liability reduces accordingly.
Depreciation Calculation
Since the lease term is 3 years, depreciation is calculated as ₹2,48,685 divided by 3, which equals
₹82,895 per year.
The entry is:
Dr Depreciation 82,895
Cr Accumulated Depreciation 82,895
Why Expense is Front-Loaded
In Year 1, depreciation is ₹82,895 and interest is ₹24,869. So total expense is ₹1,07,764. Earlier under
operating lease accounting, the expense would have been only ₹1,00,000.
Now, in initial years, expense is higher because interest is higher when the liability is larger. As the
liability reduces over time, interest reduces. This is why the expense pattern is front-loaded and
profits are lower in earlier years.
This logic is very important for interviews.
Also read- How
to Get CA Industrial Training in Top Companies? Step-by-Step
Process
IND AS 116 Summary
Before exams, you need a clear IND AS 116 summary in your mind. This standard brings almost all leases
onto the balance sheet and replaces the old operating lease concept for lessees.
Under this standard, a single accounting model is applied for lessees. A Right-of-Use asset and lease
liability are recognized at present value. The ROU asset is depreciated and interest is charged on the
liability. Short-term and low-value leases are exempt. The total expense pattern becomes front-loaded
instead of straight-line.
If you remember the logic instead of memorizing entries, numericals become much easier.
Common Mistakes Students Make in IND AS 116
Many students struggle not because the standard is difficult, but because they try to memorize without
understanding.
Conceptual mistakes include forgetting to discount lease payments, misunderstanding the lease term,
ignoring re-measurement requirements, and not understanding why interest is charged.
Numerical mistakes include wrong present value calculation, incorrect interest computation, incorrect
depreciation base, and not reducing lease liability properly after payment.
If you always think in flow format -opening liability, add interest, subtract payment, arrive at closing
liability, you will avoid most errors.
FAQs
1. What is IND AS 116 in simple words?
It is the accounting standard that requires companies to record lease agreements on the balance sheet by
recognizing a Right-of-Use asset and a lease liability.
2. What is the applicability of IND AS 116?
It applies to companies that follow the Ind AS framework as notified by MCA. Listed companies and certain
unlisted companies must comply.
3. How is IND AS 116 different from old lease accounting?
Earlier, operating leases were kept off-balance sheet. Now, almost all leases are capitalized and shown
as asset and liability.
4. Is IND AS 116 applicable to all companies?
No. It is applicable only to companies required to follow Ind AS. Companies following regular Accounting
Standards are not required to apply it.
Conclusion
Understanding IND AS 116 is not about memorizing journal entries. It is about understanding one simple
principle: if you control the right to use an asset and have an obligation to pay, you must recognize
both an asset and a liability.
Once you understand this logic, the entire structure of IND AS 116 lease accounting becomes clear.
Whether you are preparing for exams, interviews, or working in audit, clarity on this standard will give
you confidence.
Focus on concepts, practice numericals, and always connect theory with practical application. That is
how you truly master lease accounting.
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