1. What IND AS 116 requires — in plain English
Before IND AS 116, operating leases were entirely off-balance-sheet — you simply booked rent expense each month. IND AS 116 (effective 1 April 2019, converged with IFRS 16) changed this: almost every lease goes on the balance sheet, regardless of whether it was previously classified as operating or finance.
Two things are recognised on Day 1:
- Right-of-Use (ROU) asset — represents your right to use the asset for the lease term. Classified as a non-current asset, depreciated over the lease term.
- Lease liability — represents the obligation to pay future lease rentals. Classified as current (within 12 months) and non-current (beyond 12 months), and carries an interest cost each period.
Exemptions: Two types of leases can still be expensed directly — short-term leases (term ≤ 12 months) and low-value asset leases (underlying asset worth ≤ ~₹4 lakhs when new). Everything else: on balance sheet.
2. The lease we'll use throughout this article
We'll work through a single, realistic lease from start to finish. All numbers in this article flow from these inputs.
| Lessee | ABC Pvt. Ltd. |
| Asset | Commercial office space, 3rd floor, Andheri (Mumbai) |
| Commencement date | 1 April 2024 |
| Lease term | 3 years (ending 31 March 2027) |
| Rent | ₹3,00,000 per quarter, payable at end of each quarter |
| Escalation | None (fixed rent) |
| IBR | 10% p.a. |
| Initial Direct Costs (IDC) | ₹50,000 (legal fees for lease agreement) |
| Lease incentives | None |
| Renewal option | Yes — but not reasonably certain to exercise |
3. Step 1 — Identify the lease term
The lease term under IND AS 116 is the non-cancellable period plus any optional renewal periods the lessee is reasonably certain to exercise.
ABC has a renewal option, but management has confirmed they are not reasonably certain to renew — perhaps they are evaluating a different location. So the lease term = 3 years (12 quarters).
Practical note: "Reasonably certain" is a high threshold — higher than "more likely than not." If a company has exercised renewals consistently in the past and the space is business-critical, the renewal option usually qualifies for inclusion. Document your assessment.
4. Step 2 — Choose the IBR
ABC does not know the rate implicit in the lease (the lessor's internal rate), so it uses the Incremental Borrowing Rate (IBR) — the rate at which ABC could borrow to acquire an asset of similar value over a similar term.
ABC's CFO confirms the company's working capital loan rate is 10% p.a. (MCLR-linked), which is a reasonable proxy. IBR = 10% p.a.
Quarterly IBR = 10% ÷ 4 = 2.5% per quarter
5. Step 3 — Calculate the lease liability (PV of future payments)
The lease liability at commencement = present value of 12 quarterly payments of ₹3,00,000, discounted at 2.5% per quarter, payable in arrears.
Lease liability at 1 April 2024 = ₹30,77,340
Tip: The PV formula above is for end-of-period (arrears) payments. If rent is payable at the beginning of each quarter (advance), multiply the result by (1 + r): ₹30,77,340 × 1.025 = ₹31,54,273.
6. Step 4 — Recognise the ROU asset
The ROU asset at commencement is built up from three components:
ROU asset at 1 April 2024 = ₹31,27,340
This is depreciated straight-line over 3 years = ₹10,42,447 per year (₹2,60,612 per quarter).
7. Step 5 — Build the amortisation schedule
Each quarter, the lease liability:
- Accrues interest = Opening liability × 2.5%
- Reduces by the payment of ₹3,00,000
The schedule below shows all 12 quarters. The principal component = Payment − Interest.
| Qtr | Period | Opening Liability | Interest @ 2.5% | Payment | Principal | Closing Liability |
|---|---|---|---|---|---|---|
| Q1 | Apr–Jun 24 | ₹30,77,340 | ₹76,934 | ₹3,00,000 | ₹2,23,066 | ₹28,54,274 |
| Q2 | Jul–Sep 24 | ₹28,54,274 | ₹71,357 | ₹3,00,000 | ₹2,28,643 | ₹26,25,631 |
| Q3 | Oct–Dec 24 | ₹26,25,631 | ₹65,641 | ₹3,00,000 | ₹2,34,359 | ₹23,91,272 |
| Q4 | Jan–Mar 25 | ₹23,91,272 | ₹59,782 | ₹3,00,000 | ₹2,40,218 | ₹21,51,054 |
| Q5 | Apr–Jun 25 | ₹21,51,054 | ₹53,776 | ₹3,00,000 | ₹2,46,224 | ₹19,04,830 |
| Q6 | Jul–Sep 25 | ₹19,04,830 | ₹47,621 | ₹3,00,000 | ₹2,52,379 | ₹16,52,451 |
| Q7 | Oct–Dec 25 | ₹16,52,451 | ₹41,311 | ₹3,00,000 | ₹2,58,689 | ₹13,93,762 |
| Q8 | Jan–Mar 26 | ₹13,93,762 | ₹34,844 | ₹3,00,000 | ₹2,65,156 | ₹11,28,606 |
| Q9 | Apr–Jun 26 | ₹11,28,606 | ₹28,215 | ₹3,00,000 | ₹2,71,785 | ₹8,56,821 |
| Q10 | Jul–Sep 26 | ₹8,56,821 | ₹21,421 | ₹3,00,000 | ₹2,78,579 | ₹5,78,242 |
| Q11 | Oct–Dec 26 | ₹5,78,242 | ₹14,456 | ₹3,00,000 | ₹2,85,544 | ₹2,92,698 |
| Q12 | Jan–Mar 27 | ₹2,92,698 | ₹7,317 | ₹3,00,000 | ₹2,92,698 | ₹0 |
| Total | ₹5,22,660 | ₹36,00,000 | ₹30,77,340 | — | ||
Cross-check: Total interest ₹5,22,660 + Principal ₹30,77,340 = ₹36,00,000 = 12 × ₹3,00,000. ✓
Build this schedule automatically in seconds
Enter your lease details into the free Finosutra calculator — it generates the full amortisation schedule, annual rollforward, journal entries and an audit-ready Excel workbook.
Open Free IND AS 116 Calculator →8. Step 6 — Pass the journal entries
There are four recurring journal entries under IND AS 116. We'll show all of them with actual numbers from this example.
Entry 1 — Commencement date (1 April 2024)
Entry 2 — Each quarter: Finance cost (interest accrual)
Shown for Q1 (April–June 2024): Interest = ₹30,77,340 × 2.5% = ₹76,934
Entry 3 — Each quarter: Lease payment
Shown for Q1 (30 June 2024): Payment = ₹3,00,000. This repays the interest accrued (₹76,934) and reduces the principal by ₹2,23,066.
Entry 4 — Each quarter: Depreciation on ROU asset
Annual depreciation = ₹31,27,340 ÷ 3 years = ₹10,42,447. Quarterly = ₹10,42,447 ÷ 4 = ₹2,60,612
9. Step 7 — Balance sheet & P&L impact by year
Here is how ABC Pvt. Ltd.'s financial statements are affected in each of the three years of the lease.
Lease liability — year-end closing balances
| Year-end | Closing Lease Liability | Current (≤12 months) | Non-current (>12 months) |
|---|---|---|---|
| 31 Mar 2025 | ₹21,51,054 | ₹9,22,448 | ₹12,28,606 |
| 31 Mar 2026 | ₹11,28,606 | ₹11,28,606 | — |
| 31 Mar 2027 | ₹0 | — | — |
How to split current vs. non-current: Current = principal payments due within the next 12 months (sum of principal columns from the amortisation schedule for the coming 4 quarters). Non-current = the remainder.
P&L impact — what hits the income statement each year
| FY | Depreciation (Opex) | Finance Cost (Below EBIT) | Total P&L Charge | Old Rent Expense |
|---|---|---|---|---|
| FY 2024-25 | ₹10,42,447 | ₹2,73,714 | ₹13,16,161 | ₹12,00,000 |
| FY 2025-26 | ₹10,42,447 | ₹1,77,552 | ₹12,19,999 | ₹12,00,000 |
| FY 2026-27 | ₹10,42,447 | ₹71,409 | ₹11,13,856 | ₹12,00,000 |
| Total over 3 years | ₹5,22,675* | ₹36,49,016 | ₹36,00,000 | |
* Minor rounding difference vs. amortisation schedule due to schedule rounding. Total P&L = Total payments (₹36,00,000) + IDC (₹50,000) = ₹36,50,000 over the lease life.
Key observation: In early years, total P&L charge is slightly higher than old rent expense (₹13.16L vs ₹12L in FY 25) because the finance cost is front-loaded. In later years, it falls below. This is because interest is calculated on the declining lease liability balance.
Balance sheet snapshot — 31 March 2025
EBITDA impact: Under IND AS 116, depreciation (₹10.42L/year) replaces operating lease rent (₹12L/year) above the EBITDA line. ABC's EBITDA improves by ₹1.58L per year — the finance cost sits below EBIT and doesn't affect EBITDA. Companies with large lease portfolios (retail, hospitality) see significant EBITDA uplift from this standard.
10. Common errors CAs make — and how to avoid them
1. Using the wrong IBR
The IBR should be entity-specific and tenor-matched. Using a generic benchmark (like 8% for all leases) without documentation invites an audit query. Always document the rationale — reference the company's latest term loan sanction letter, MCLR + spread, or a comparable borrowing.
2. Ignoring the renewal option
If a lease has a renewal option and management is reasonably certain to exercise it (e.g., the premises are the company's registered office and no alternatives have been scouted), the renewal period must be included in the lease term. Ignoring it understates the lease liability.
3. Using annual discounting for monthly/quarterly payments
If rent is paid quarterly, use a quarterly IBR (annual rate ÷ 4) and n = number of quarters. Applying the annual rate directly to annual cash flows gives a different answer — the quarterly PV formula is correct.
4. Forgetting to split the lease liability between current and non-current
The current portion = principal repayments due within the next 12 months. This must be disclosed separately in the balance sheet under Schedule III.
5. Capitalising all IDCs without checking
Only incremental direct costs qualify — fees paid to obtain the lease that wouldn't have been incurred otherwise. Salaries of the in-house legal team reviewing the agreement do not qualify, even if they spend significant time on it.