Accounting for Financial Instruments and Leases
Classification of financial assets
Ind AS 109 classifies assets by business model and contractual cash flow characteristics (the SPPI test). Amortised cost applies where held to collect with solely principal-and-interest cash flows; FVOCI where held to collect and sell; FVTPL otherwise. Equity investments are FVTPL unless an irrevocable FVOCI election is made, in which case dividends go to profit or loss but gains are never recycled. Expected credit losses apply to amortised cost and FVOCI debt instruments.
Leases
Ind AS 116 removes the lessee's operating/finance split. At commencement the lessee recognises a right-of-use asset and a lease liability at the present value of lease payments, discounted at the rate implicit in the lease or, failing that, the incremental borrowing rate. Exemptions exist for short-term (12 months or less) and low-value assets. The ROU asset is depreciated; the liability accrues interest.
Worked example
Five-year lease, annual payments ₹1,00,000 in arrears, incremental borrowing rate 10%, annuity factor 3.7908. Lease liability = ₹3,79,080. Initial direct costs of ₹20,000 are added to the ROU asset, giving ₹3,99,080. Year 1 interest = ₹37,908; straight-line depreciation = ₹79,816. Recording ₹5,00,000 as the liability overstates both liability and asset.
Traps
- Assuming the FVOCI equity election can be recycled.
- Computing the lease liability without discounting, or using the mortgage rate instead of the incremental borrowing rate.
- Merging leasehold improvements with the ROU asset.