Ind AS 116 Leases: How to Capitalise an Operating Lease
- Under Ind AS 116, almost every lease you sign must appear on your balance sheet as a Right-of-Use asset and a corresponding lease liability — not simply as a rent expense.
- The lease liability is measured at the present value of future lease payments, discounted at your incremental borrowing rate if the lessor's implicit rate is unavailable.
- Short-term leases (12 months or less) and low-value asset leases qualify for practical expedients that let you keep them off the balance sheet.
If your company rents office space, a warehouse, or equipment under a multi-year agreement, Ind AS 116 Leases requires you to record that arrangement on your balance sheet — even if your old lease contract was always treated as a simple monthly expense. The standard replaced Ind AS 17 for accounting periods beginning on or after 1 April 2019. The bottom line: you must recognise a Right-of-Use (ROU) asset and a lease liability on day one of the lease. This article walks you through exactly how to do that, with real numbers.
What Ind AS 116 Leases Actually Changes
Under the old Ind AS 17, operating leases stayed completely off the balance sheet. The tenant just booked rent expense each month. Ind AS 116 eliminated that treatment for lessees. Now, with very few exceptions, every lease of 12 months or more creates two new line items on your balance sheet:
- ROU Asset — shown under Property, Plant and Equipment or as a separate line
- Lease Liability — the present value of all future lease payments, split into current and non-current
The profit-and-loss impact also changes. Instead of rent expense, you now see depreciation on the ROU asset and interest expense on the lease liability. In the early years this front-loads expenses slightly, so EBITDA goes up (rent is removed) but finance costs go up too.
Which Leases Are Exempt?
Ind AS 116 gives lessees two practical expedients. You can elect to keep a lease off the balance sheet if:
- Short-term leases: the lease term at commencement is 12 months or less (including renewal options you are reasonably certain to exercise).
- Low-value assets: the underlying asset, when new, is of low value. The IASB had US$5,000 in mind as a reference point; the MCA has not prescribed a specific rupee threshold, so Indian companies typically apply a policy consistently — many use ₹3,50,000 to ₹5,00,000 as an internal cut-off.
If you qualify for either exemption, you simply continue booking the payments as rent expense on a straight-line basis.
Step-by-Step: How to Capitalise a Lease
- Identify the lease: Does the contract give you the right to control the use of an identified asset for a period of time in exchange for consideration? If yes, it is a lease under Ind AS 116.
- Determine the lease term: Include non-cancellable period plus optional renewal periods you are reasonably certain to exercise.
- Identify the lease payments: Fixed payments (less any lease incentives receivable), variable payments based on an index or rate, residual value guarantees you will likely pay, and purchase option price if reasonably certain to be exercised.
- Choose the discount rate: Use the interest rate implicit in the lease. If that cannot be readily determined — which is common for property leases — use your incremental borrowing rate (IBR), i.e., the rate at which you could borrow a similar amount for a similar term with similar security.
- Calculate the lease liability: Present value of future lease payments at the discount rate.
- Calculate the ROU asset: Lease liability + initial direct costs + prepaid lease payments + estimated restoration costs – any lease incentives received.
- Subsequent measurement: Unwind the lease liability using the effective interest method. Depreciate the ROU asset on a straight-line basis over the shorter of the lease term or the useful life of the asset.
Worked Example with Real Rupee Numbers
Sharma Exports Pvt Ltd signs a 3-year office lease starting 1 April 2025. Annual rent is ₹6,00,000 payable at the start of each year (advance). The company's IBR is 9% per annum. There are no initial direct costs or lease incentives.
Step 1 – Lease payments: ₹6,00,000 × 3 years. Since payments are in advance, this is an annuity-due.
Step 2 – Present value (Lease Liability at commencement):
- Year 1 payment (at t=0): ₹6,00,000 ÷ (1.09)⁰ = ₹6,00,000
- Year 2 payment (at t=1): ₹6,00,000 ÷ 1.09 = ₹5,50,459
- Year 3 payment (at t=2): ₹6,00,000 ÷ (1.09)² = ₹5,05,009
- Total Lease Liability = ₹16,55,468
Step 3 – ROU Asset = ₹16,55,468 (no adjustments in this example)
Journal entry on 1 April 2025:
- Dr. ROU Asset ₹16,55,468
- Cr. Lease Liability ₹16,55,468
The first rent cheque of ₹6,00,000 is then debited to Lease Liability (not rent expense), reducing it to ₹10,55,468.
Amortisation Table (First Two Years)
| Date | Opening Liability (₹) | Payment (₹) | Interest @ 9% (₹) | Closing Liability (₹) |
|---|---|---|---|---|
| 1 Apr 2025 | 16,55,468 | 6,00,000 | — | 10,55,468 |
| 31 Mar 2026 | 10,55,468 | — | 94,992 | 11,50,460 |
| 1 Apr 2026 | 11,50,460 | 6,00,000 | — | 5,50,460 |
| 31 Mar 2027 | 5,50,460 | — | 49,541 | 5,99,001* |
*Rounding differences of ~₹9 arise from truncated decimals above; in practice use full precision.
The ROU Asset of ₹16,55,468 is depreciated over 3 years: ₹5,51,823 per year.
If you find these calculations tedious, the Ind AS Helper on KyaTax can build the full amortisation schedule automatically once you enter the lease terms.
Disclosure Requirements You Cannot Ignore
Ind AS 116 demands significant disclosures in the notes to financial statements. At a minimum you must disclose:
- Depreciation charge on ROU assets (by class of underlying asset)
- Interest expense on lease liabilities
- Short-term and low-value lease expense recognised in P&L
- Total cash outflow for leases
- Maturity analysis of lease liabilities (undiscounted)
- Carrying amount of ROU assets at end of period
Common Mistakes Under Ind AS 116
- Using the wrong discount rate. Many companies use their term loan rate as IBR without adjusting for the nature of the asset, currency, or remaining lease term. IBR must reflect what you would pay to borrow, over a similar term, with similar collateral, in the same economic environment as the lease.
- Ignoring renewal options. If your lease has a 3-year term with a 3-year renewal option and you have already spent ₹40 lakh fitting out the office, you are almost certainly going to renew. That makes the effective lease term 6 years — and your liability calculation must reflect that from day one.
- Treating a rent-free period as simply zero payments. A 3-month rent-free period at the start is a lease incentive that reduces the ROU asset, not a reason to skip those months in the payment schedule. The zero payment months are still part of the lease term.
- Forgetting to reassess when lease terms change. If you renegotiate rent upward by ₹50,000 per month mid-lease, that is a lease modification and may require remeasuring the lease liability at the revised discount rate on the modification date.
- Applying the low-value exemption to a fleet of cars. The low-value test applies to each individual asset, not a portfolio. However, if you lease 50 cars and each car individually has a high value when new, they do not qualify as low-value even if you consider them operationally insignificant.
Impact on Financial Ratios — What Directors Should Know
Capitalising leases under Ind AS 116 meaningfully changes key ratios:
| Ratio | Effect of Ind AS 116 | Reason |
|---|---|---|
| EBITDA | Increases | Rent expense replaced by depreciation + interest, both below EBITDA line |
| Debt-to-Equity | Increases | New lease liability added to total debt |
| Return on Assets | Decreases initially | Asset base grows with ROU assets |
| Interest Coverage | Decreases | Interest expense on lease liability added to finance costs |
| Operating Cash Flow | Increases | Lease payments reclassified from operating to financing activities |
Lenders and investors increasingly adjust for these effects, but covenants in older loan agreements may still use the pre-Ind AS 116 definitions of debt — check your loan documents before your first Ind AS 116 filing.
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Open Ind AS Helper →Frequently asked questions
Does Ind AS 116 apply to all companies in India?
Ind AS 116 applies to all companies that are required to follow Indian Accounting Standards — broadly, listed companies and unlisted companies above prescribed net worth thresholds. Companies that follow AS (the older ICAI standards) are not covered by Ind AS 116 and instead follow AS 19 for leases, which still permits operating lease treatment off the balance sheet.
What is the incremental borrowing rate and how do I determine it?
The incremental borrowing rate (IBR) is the rate of interest you would have to pay to borrow, over a similar term and with similar security, the funds necessary to obtain an asset of similar value to the ROU asset in a similar economic environment. In practice, most Indian companies start with their existing term loan rate from a bank and adjust it for differences in loan tenure, collateral, and the date of the lease commencement. Document your IBR methodology — auditors routinely challenge this.
Can I avoid capitalising a lease by signing multiple 11-month agreements?
Only if you are genuinely uncertain about whether you will renew and there is real commercial substance to that uncertainty. If you sign back-to-back 11-month leases for the same premises year after year, auditors and regulators can look through the structure and treat the arrangement as a single long-term lease. Ind AS 116 requires you to consider the lease term as the non-cancellable period plus optional periods you are reasonably certain to exercise.
How do variable lease payments based on sales percentage get treated?
Variable lease payments that depend on sales, usage, or another variable that is not an index or rate are excluded from the lease liability calculation. They are recognised as an expense in the period in which the event or condition that triggers those payments occurs. Only variable payments linked to an index (like CPI or WPI) or a rate are included in the lease liability and remeasured when the index or rate changes.
General information for FY 2026-27, not professional advice for your specific case. Rules change — verify against the latest notification or ask a KyaTax expert.
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