ValuePickr Forum

Impact of Indian Accounting Standard Ind AS 116 Lease Accounting on indian industries

It will be very interesting to know the know the impact of Ind AS 116 on lease accounting applicable to corporates and alike from April 1, 2019. Early estimates suggests that Indian Accounting Standar Board IASB suggests additional impact of USD 2.18 trillion on operating lease to be recognized as finance lease.

From top of my head I can recollect the Airlines, telecom and retail industry that have significant exposure to operating leases. There will be a negative impact on debt/equity ratio. Higher interest costs and increase depreciation hit. So it seems that EBITDA margins would be positive.

Any other exposure in terms of industry which i may be missing out? Please share your thoughts.

Interesting topic. Your assessment is largely correct. Let me put down what i think would happen to companies acting as lessee’s(say Airtel, Indigo, Jet etc) and as lessors(say Bharti Infratel)

As a lessee:
The primary issue would be that what is considered opex today would be moving to balance sheet(which would make the balance sheet bulky to say the least). My assessment is that if companies can make appropriate adjustments to the useful life of assets and and discounting rates the P&L will not have any significant impact. I think this would largely be a 2 quarter phenomena and the industry will just move on. To summarize - all Airline and Telecom companies having a strong balance sheet will survive in the long run and others will perish irrespective of any change in accounting standard.

As a lessor:
SEC has brought in a practical expedient(ASU 2018-11 issued during June 2018) to ASC 842(US GAAP equivalent to ASC 116) which would help companies(as lessors) to continue accounting for operating lease the way it is today. Considering the track record of standard setters in India - it is highly likely that we would follow the suit.

The crux of this ASU is as below:
Specifically, an entity should determine whether the nonlease component (or components) associated with the lease component is the predominant component of the combined component. If so, the entity is required to account for the combined component in accordance with ASC 606. Otherwise, the entity must account for the combined component as an operating lease in accordance with ASC 842.” - which simply means that if the objective of the contract is to provide pure service and lease of asset is only used as a tool for delivery of such services then one can directly use the principles under revenue recognition standard(ASC 606/ Ind AS 115) instead of lease standard.

Adoption of this practical expedient would reduce the head ache of telecom industry significantly as service is the larger component of telecom industry.

Anyone interested in the original text of this ASU can refer here

AJ

3 Likes

It will also impact logistics , media and hospitality industries
eg Blue dart, Jubilant food, Mahindra holidays , coffee Day Enterprises, PVR, Inox

Profitability ratio like return on asset/ asset turnover will decrease
Balance sheet are going to be significantly stressed . As liabilities increases plus interest coverage ratio decreases companies will have lower debt raising capabilities. How Credit rating agency take this into account is to be seen(Might increase cost of debt for companies???)

Can some one explain this AS 116 Lease Accounting in layman terms with an simple example. Not a CA, hard to grasp what changes are made.

1 Like

Enclosed is a brief note which covers impact in brief manner. Don’t have access to detailed note. Someone could help out on that.

As per me, following impact would happen:

  1. EBITDA Margins could expand while also increasing depreciation expenses. This would increase operating leverage ratios and reflect business fundamentals in much better manner.

  2. Under CAPM, higher leverage would mean higher beta if someone levers and unlevers beta. Also, directly computing effective interest rates would become much more difficult.

  3. Higher asset base could reduce RoCE for retail businesses if significant assets were financed using off-balancesheet financing (long term leases). Further, business on balance sheet face would sound riskier than what it is inherently.

  4. Earnings would be hit for majority of retail businesses given that they have recently expanded and negative drag would be there

  5. No impact on taxation front as tax rules are specific and clear on this matter.

Strategy Ind-AS 116 - Valuations unscathed Results Kotak Mahindra Bank Justdial Unearned revenue growth gets a jolt.pdf (571.9 KB)

Ind AS 116 on Lease Accounting has significantly impacted financial statements – both P & L and Balance Sheet of Indian companies this year. Under this, operating lease is capitalized as a Right of Use Asset in the Balance Sheet and depreciated over the lease term on a straight line basis. The liability is capitalized at present value of minimum lease payments to be made over the term of the lease. This has impacted all the below the topline metrics such as EBITDA, EBIT, margins, CFO etc. making Y-o-Y comparison difficult.

Does anyone know what is the discount rate used for arriving at the present value of minimum lease payments – is every company using its own rate or has a common rate been prescribed by any body such as the ICAI?