Ind AS 116 Transition: Either restate comparatives or recognize cumulative effect by retrospective application : 30-09-2019

Query

An Ind AS compliant company, say A Ltd. took an office building on lease at a time when old lease standard, Ind AS 17 Leases, was applicable. The lease, at the inception, was classified as operating lease and accordingly lease rentals were recognized as expense on a straight-line basis over the lease term in accordanceConsequently, in the balance sheet as at 31st March, 2019 of A Ltd. there stands a rent equalization liability. However, from 1st April, 2019, the new Ind AS on leases Ind AS 116, Leases is effective.

How the rent equalization liability should be treated on transition to Ind AS 116?

Answer

According to para C5 of Ind AS 116, on first-time application of this Standard, the effects of change in accounting treatment of existing lease agreements should be provided either:

  (a) retrospectively to each prior reporting period presented together with current year’s financial statements by applying the provisions of Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors; or

  (b) retrospectively by adjusting the cumulative effects at the time of initial application of Ind AS 116 with retained earnings, or any other appropriate component of equity

Retrospective application by restating financial statements of prior periods presented

In this case, the financial information related to existing leases as disclosed in the financial statements of prior periods presented along with current year’s financial statements, shall be restated as per accounting principles of Ind AS 116. The cumulative effect shall also be given to opening balance of each affected component of equity (generally retained earnings) for the earliest prior period presented. The restatement is done assuming the new Ind AS 116 had always been applied for existing leases. However, if determination of cumulative effect or/and period-specific effects are impracticable then Ind AS 116 shall be applied retrospectively to each prior reporting period presented to the extent determination of effects is practicable.

In the given case, assuming there is no impracticability of determination of cumulative effect or period-specific effects, A Ltd., being a lessee, should recognise the lease liability and related right of use asset at the beginning of the preceding period, i.e., on 1st April, 2018 as if Ind AS 116 had always been applied from the beginning of the lease. Any difference between the right of use asset together with the amount of lease rent equalization liability and the amount of lease liability shall be adjusted with retained earnings or any other appropriate head of equity. Both, the lease liability and right of use asset shall be determined in accordance normal provisions of Ind AS 116. The following journal entry may be passed:

Right-of-use assetDr.
Rent equalization liabilityDr.
Retained earnings/other appropriate component (balancing figure)Dr/Cr.
To Lease liability 

Furthermore, the financial statements of 2018-19 shall also be restated at the time of presentation of financial statements of current year, i.e., 2019-20.

If the retrospective effects are material then a third balance sheet as at 1 April, 2018 shall also be presented together with current year’s financial statements. In such case, the lease liability and right of use asset shall be recorded in this balance sheet and then financial statements of 2018-19 shall be restated.

Retrospective application by recognizing cumulative effects at the time of initial application of Ind AS 116

Where a lessee company decides to apply the provision of Ind AS 116 retrospectively by recognizing cumulative effects at the time of initial application of this Standard in retained earnings or any other appropriate head of equity, the company shall recognise a lease liability and a right of use asset in respect of a lease at the date of initial application of Ind AS 116. The lease liability shall be measured at the present value of the remaining lease payments discounted using the lessee’s incremental borrowing rate at the date of initial application of Ind AS 116.

The right of use asset at the date of initial application of Ind AS 116 is measured by any of the following two ways:

  1. It can be measured at its carrying amount as if Ind AS 116 had been applied since inception of the lease. The lessee’s incremental borrowing rate at the date of initial application shall be used for this purpose; or

  2. It can be measured at the amount equal to the lease liability as measured above and further adjusted by prepaid or accrued lease payments relating to that lease already recorded in the balance sheet immediately before the date of initial application.

Additionally, the right of use asset so measured should be checked for impairment under Ind AS 36, Impairment of Assets.

When the lessee chooses first method to measure right of use asset, the difference between the value of right of use asset together with rent equalization liability and the amount of lease liability would be recorded in retained earnings or any other appropriate head of equity.

When the lessee chooses second way to measure right of use asset, the rent equalization liability would be treated as accrued lease payments and, hence, same should be deducted from the value of lease liability at the date of initial application of Ind AS 116. In this the following journal entry may be passed:

Right of use asset (balancing figure)Dr.
Rent equalization liabilityDr.
To Lease liability 

Relevant extracts

Para C5 of Ind AS 116: A lessee shall apply this Standard to its leases either:

 (a) retrospectively to each prior reporting period presented applying Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors; or

 (b) retrospectively with the cumulative effect of initially applying the Standard recognised at the date of initial application in accordance with paragraphs C7-C13

Para C7 of Ind AS 116: If a lessee elects to apply this Standard in accordance with paragraph C5(b), the lessee shall not restate comparative information. Instead, the lessee shall recognise the cumulative effect of initially applying this Standard as an adjustment to the opening balance of retained earnings (or other component of equity, as appropriate) at the date of initial application.

Para C8 of Ind AS 116: If a lessee elects to apply this Standard in accordance with paragraph C5(b), the lessee shall:

 (a) recognise a lease liability at the date of initial application for leases previously classified as an operating lease applying Ind AS 17. The lessee shall measure that lease liability at the present value of the remaining lease payments, discounted using the lessee’s incremental borrowing rate at the date of initial application.

 (b) recognise a right-of-use asset at the date of initial application for leases previously classified as an operating lease applying Ind AS 17. The lessee shallchoose, on a lease-by-lease basis, to measure that right-of-use asset at either:

  (i) its carrying amount as if the Standard had been applied since the commencement date, but discounted using the lessee’s incremental borrowing rate at the date of initial application; or

  (ii) an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease recognised in the balance sheet immediately before the date of initial application.

 (c) apply Ind AS 36, Impairment of Assets, to right-of-use assets at the date of initial application, unless the lessee applies the practical expedient in paragraph C10(b).

Para 22 of Ind AS 8: Subject to paragraph 23, when a change in accounting policy is applied retrospectively in accordance with paragraph 19(a) or (b), the entity shall adjust the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied.

Para 23 of Ind AS 23: When retrospective application is required by paragraph 19(a) or (b), a change in accounting policy shall be applied retrospectively except to the extent that it is impracticable to determine either the period-specific effects or the cumulative effect of the change.

Reference

   –  Issue 2 of Ind AS Technical Facilitation Group (ITFG) Clarification Bulletin 21

Source : Times of India