IND AS 116, or Indian Accounting Standard 116, represents a significant overhaul in the way companies account for leases. Introduced to align with the global standards of IFRS 16, this standard affects not only how leases are reported but also how businesses manage their financials and make strategic decisions.

For companies involved in leasing arrangements, the shift to IND AS 116 brings both challenges and opportunities. Here's a detailed breakdown of what this means for your business and how to navigate these changes.

IND AS 116 brings greater transparency by recognizing leases on the balance sheet, transforming how businesses account for their lease obligations. This shift not only enhances financial reporting but also provides businesses with the insights needed for smarter decision-making and strategic growth.

What is IND AS 116?

IND AS 116, effective from April 1, 2019, requires companies to recognize lease agreements on their balance sheets. Under this standard, lessees must account for most leases as a right-of-use asset and a corresponding lease liability. This eliminates the previous distinction between operating and finance leases for lessees, bringing almost all leases onto the balance sheet.

Key Changes Under IND AS 116:

• Recognition of Lease Assets and Liabilities: Lessees must recognize a right-of-use (ROU) asset and a lease liability for virtually all leases, including operating leases, which were previously not recorded on the balance sheet. This impacts key financial ratios such as debt-to-equity and return on assets, as the lease liability is now reflected as debt.
• Measurement of Lease Liability: Lease liabilities are measured at the present value of future lease payments, discounted at the rate implicit in the lease or the lessee’s incremental borrowing rate.
• Impact on Profit and Loss: The accounting treatment for leases changes. Instead of lease rental expenses, businesses now recognize depreciation of the right-of-use asset and interest expense on the lease liability. This can affect operating profit, EBITDA, and net income in the initial years of the lease term.
• Short-term Leases and Low-value Leases: As a relief, companies have the option to exclude short-term leases (12 months or less) and leases of low-value assets from this recognition requirement. For these leases, companies can continue accounting for them on a straight-line basis, without bringing them onto the balance sheet.
• Sale and Leaseback Transactions: IND AS 116 also has specific guidance on sale and leaseback transactions, which are more closely aligned with the economic substance of the transaction rather than just the legal form.

Challenges for Businesses Under IND AS 116:

• Complex Implementation: Implementing IND AS 116 requires a thorough understanding of each lease agreement and its terms. Many businesses may face challenges in tracking and updating lease data accurately.
• Revised Financial Statements: The transition to IND AS 116 will have a profound impact on financial statements, including changes to the balance sheet, P&L, and cash flow statements. Accurate reporting requires careful adjustments and recalculations.
• Effect on Key Performance Indicators (KPIs): Companies need to consider how the changes in lease accounting affect their KPIs. The impact on debt-to-equity ratio, return on assets, and other financial metrics might alter business decisions, investor perceptions, and loan covenants.

Opportunities for Businesses Under IND AS 116:

• Better Decision Making: With more accurate lease accounting, businesses can better assess the true cost of leasing assets versus buying them, which can lead to more informed strategic decisions.
• Improved Transparency for Investors: By recognizing leases on the balance sheet, companies provide more transparency regarding their lease obligations, improving the quality of financial reporting and investor confidence.
• Enhanced Lease Management: The new standard encourages businesses to focus more on managing leases effectively, potentially leading to optimized leasing strategies and cost savings.

Conclusion:

While IND AS 116 presents a challenge for businesses, it also opens the door to better financial transparency and more informed decision-making. By leveraging the expertise of PinnValor Group, you can stay ahead of the curve, ensuring your financial reporting aligns with global standards while maximizing the strategic advantages.

In what ways can businesses leverage the transparency provided by IND AS 116 to build investor confidence?