IND AS-2: VALUATION OF INVENTORIES 1

IND AS-2: VALUATION OF INVENTORIES

CONCEPT 1: OBJECTIVE
The objective of this Standard is to prescribe the accounting treatment for inventories.
This Standard provides the guidance for determining the cost of inventories and for
subsequent recognition as an expense, including any write-down to net realizable value.
It provides guidance on the techniques for the measurement of cost, such as the standard
cost method or retail method. It also outlines acceptable methods of determining cost,
including specific identification, first-in-first-out and weighted average cost method.

CONCEPT 2: SCOPE

• This standard is applicable to all inventories except:

(a) Financial instruments (to be accounted under Ind AS 32, Financial Instruments:
Presentation and Ind AS 109, Financial Instruments);
(b) Biological assets (i.e. living animals or plants) related to agricultural activity and
agricultural produce at the point of harvest (to be accounted under Ind AS 41,
Agriculture); and
(c) Work-in-progress arising under construction contracts including directly related
service contracts (accounted under Ind AS 115 Revenue from Contracts)
• This Standard does not apply to the measurement of inventories held by:
(a) Producers of agricultural and forest products, agricultural produce after harvest,
and minerals and mineral products, to the extent that they are measured at net
realizable value in accordance with well-established practices in those industries.
When such inventories are measured at net realizable value, changes in that value
are recognised in profit or loss in the period of the change
(b) Commodity broker-traders who measure their inventories at fair value less costs
to sell.
When such inventories are measured at net realizable value/ fair value less costs
to sell, changes in those values are to be recognised in profit or loss in the period
of the change.

CONCEPT 3: RELEVANT DEFINITIONS

The following are the key terms used in this standard:

1) Inventories are assets:

(a) held for sale in the ordinary course of business; (Finished Goods)
 2 IND AS-2: VALUATION OF INVENTORIES

(b) in the process of production for such sale; or (Work in progress)

(c) in the form of materials or supplies to be consumed in the production process or
in the rendering of services. (Raw material)

In the process of
production for such sale

In the form of
Held for sale in the
materials and supplies
ordinary course of
to be consumed in the
business
production process
or in the rendering of
Inventories services
are assets

2) Inventories encompass of:

a) goods purchased and held for resale (e.g. merchandise purchased by a retailer
and held for resale, or land and other property held for resale);
b) finished goods produced, or work in progress being produced, by the entity; and
includes
c) materials and supplies awaiting use in the production process.
In the case of a service provider, inventories include the costs of the service, for
which the entity has not yet recognised the related revenue (see Ind AS 115 Revenue
from Contracts).

3) Net realisable value is the estimated selling price in the ordinary course of business
less the estimated costs of completion and the estimated costs necessary to make the
sale.
Net realisable value refers to the net amount that an entity expects to realize from
the sale of inventory in the ordinary course of business. Fair value reflects the price
at which an orderly transaction to sell the same inventory in the principal (or most
advantageous) market for that inventory would take place between market participants
at the measurement date. The former is an entity-specific value; the latter is not. Net
realisable value for inventories may not equal fair value less costs to sell.
4) Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date. (Ind AS 113, Fair Value Measurement.)
 IND AS-2: VALUATION OF INVENTORIES 3

CONCEPT 4: MEASUREMENT OF INVENTORIES

Inventories shall be measured at the lower of cost and net realisable value.

At the lower of

Cost Net realisable value

1) Cost of inventories
Cost of Inventories comprises:
a) All costs of purchase;
b) Costs of conversion; and
c) Other costs incurred in bringing the inventories to their present location and
condition.

Cost of Purchase
Cost

Conversion Cost

Other cost to bring inventory to present location and condition

2) Cost of purchase
The costs of purchase of inventories include:
a) The purchase price,
b) Import duties and other taxes (other than those subsequently recoverable by
the entity from the taxing authorities),
c) Transport, handling and
d) Other costs directly attributable to the acquisition of finished goods, materials
and services.
Any trade discounts, rebates and other similar items are deducted in determining the
costs of purchase of inventory.
 4 IND AS-2: VALUATION OF INVENTORIES

Purchase Price

Import duties and other taxes

Cost of purchase

Transport, handing and

Other cost to bring inventory to present location and condition

Less trade discounts, rebates and other similar items

3) Cost of conversion
• The costs of conversion of inventories include costs directly related to the units of
production, such as:
a) direct material, direct labour and other direct costs; and
b) a systematic allocation of fixed and variable production overheads that are
incurred in converting materials into finished goods.

Direct material
Cost of conversion

Direct labour

Other direct costs

Overheads (fixed and variable production overheads)

• Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, such as depreciation and maintenance of
factory buildings and equipment, and the cost of factory management and administration.
• Allocation of fixed production overheads to the costs of conversion is based on the normal
capacity of the production facilities. Normal capacity is the production expected to be
achieved on average over a number of periods or seasons under normal circumstances,
taking into account the loss of capacity resulting from planned maintenance. The actual
level of production may be used if it approximates normal capacity.
• When production levels are abnormally low, unallocated overheads are recognised as an
expense in the period in which they are incurred. In periods of abnormally high production,
the amount of fixed overhead allocated to each unit of production is decreased so that
 IND AS-2: VALUATION OF INVENTORIES 5

inventories are not measured above cost.

• Variable production overheads are those indirect costs of production that vary directly,
or nearly directly, with the volume of production, such as indirect materials and indirect
labour. Variable production overheads are allocated to each unit of production on the
basis of the actual use of the production facilities.

EXAMPLE:
Pluto ltd. has a plant with the normal capacity to produce 5,00,000 unit of a product per
annum and the expected fixed overhead is `15,00,000. Fixed overhead on the basis of
normal capacity is `3 per unit (15,00,000|5,00,000).

CASE 1:
Actual production is 5,00,000 units. Fixed overhead on the basis of normal capacity and
actual overhead will lead to same figure of `15,00,000. Therefore, it is advisable to include
this on normal capacity.

CASE 2:
Actual production is 3,75,000 units. Fixed overhead is not going to change with the change
in output and will remain constant at `15,00,000, therefore, overheads on actual basis is `4
p|u (15,00,000|3,75,000).
Hence by valuing inventory at `4 each for fixed overhead purpose, it will be overvalued and
the losses of `3,75,000 will also be included in closing inventory leading to a higher gross
profit then actually earned.
Therefore, it is advisable to include fixed overhead per unit on normal capacity to actual
production (3,75,000 X 3) `11,25,000 and balance `3,75,000 shall be transferred to Profit
& Loss Account.

CASE 3:
Actual production is 7,50,000 units. Fixed overhead is not going to change with the change
is output and will remain constant at `15,00,000, therefore, overheads on actual basis is `2
(15,00,000|7,50,000).
Hence by valuing inventory at `3 each for fixed overhead purpose, we will be adding the
element of cost to inventory which actually has not been incurred. At `3 per unit, total
fixed overhead comes to `22,50,000 whereas, actual fixed overhead expense is only
`15,00,000. Therefore, it is advisable to include fixed overhead on actual basis (7,50,000
X 2) `15,00,000.
 6 IND AS-2: VALUATION OF INVENTORIES

4) Other costs
• Other costs are included in the cost of inventories only to the extent that they are
incurred in bringing the inventories to their present location and condition. Cost to
be excluded from the cost of inventories and recognised as expenses in the period in
which they are incurred are:
a) abnormal amounts of wasted materials, labour or other production costs;
b) storage costs, unless those costs are necessary in the production process before
a further production stage;
c) administrative overheads that do not contribute to bringing inventories to their
present location and condition; and
d) selling costs.
• The extent to which borrowing cost is included in the cost of inventories is determined
on the basis of the requirement of Ind AS 23 Borrowing Costs.
• An entity may acquire inventories on deferred settlement terms. When the
arrangement effectively contains a financing element, that element, for example a
difference between the purchase prices for normal credit terms and the amount paid,
is recognised as interest expense over the period of the financing.

  EXAMPLE 1: COST OF INVENTORY

Venus Trading Company purchases cars from several countries and sells them to Asian
countries. During the current year, this company has incurred following expenses:
1. Trade discounts on purchase.
2. Handling costs relating to imports
3. Salaries of accounting department
4. Sales commission paid to sales agents.
5. After sales warranty costs
6. Import duties
7. Costs of purchases (based on supplier’s invoices)
8. Freight expense
9. Insurance of purchases
10. Brokerage commission paid to indenting agents
Evaluate which costs are allowed by Ind AS 2 for inclusion in the cost of inventory in the
books of Venus.
 IND AS-2: VALUATION OF INVENTORIES 7

SOLUTION
Items number 1, 2, 6, 7, 8, 9, 10 are allowed by Ind AS 2 for the calculation of cost of
inventories. Salaries of accounts department, sales commission, and after sale warranty
costs are not considered to be the cost of inventory therefore they are not allowed by Ind
AS 2 for inclusion in cost of inventory and are expensed off in the profit and loss account.

CONCEPT 5:
ALLOCATION OF COST TO JOINT PRODUCTS AND BY-PRODUCTS

• A production process may result in more than one product being produced simultaneously.
This is the case, for example, when joint products are produced or when there is a main
product and a by-product.
• When the costs of conversion of each product are not separately identifiable, they are
allocated between the products on a rational and consistent basis. The allocation may
be based, for example, on the relative sales value of each product either at the stage
in the production process when the products become separately identifiable, or at the
completion of production.
• Most by-products, by their nature, are immaterial. When this is the case, they are often
measured at net realisable value and this value is deducted from the cost of the main
product. As a result, the carrying amount of the main product is not materially different
from its cost.

CONCEPT 6: COST OF INVENTORIES OF SERVICE PROVIDER

To the extent that service providers have inventories, they measure them at the costs of
their production. These costs consist primarily of the labour and other costs of personnel
directly engaged in providing the service, including supervisory personnel, and attributable
overheads. Labour and other costs relating to sales and general administrative personnel are
not included but are recognised as expenses in the period in which they are incurred. The
cost of inventories of a service provider does not include profit margins or non-attributable
overheads that are often factored into prices charged by service providers.

CONCEPT 7: COST OF AGRICULTURAL PRODUCE

HARVESTED FROM BIOLOGICAL ASSETS
In accordance with Ind AS 41, Agriculture, inventories comprising agricultural produce that
an entity has harvested from its biological assets are measured on initial recognition at
their fair value less costs to sell at the point of harvest. This is the cost of the inventories
at that date for application of this Standard.
 8 IND AS-2: VALUATION OF INVENTORIES

CONCEPT 8: TECHNIQUES FOR THE MEASUREMENT OF COST

• Techniques for the measurement of the cost of inventories, such as the standard cost
method or the retail method, may be used for convenience if the results approximate to
actual cost.
• Standard Cost Method: Cost is based on normal levels of materials and supplies, labour
efficiency and capacity utilisation. They are regularly reviewed and revised where
necessary

Measurement •  Retail method

Techniques •  Standard cost

• Retail Method: Cost is determined by reducing the sales value of the inventory by
the appropriate percentage gross margin. The percentage used takes into consideration
inventory that has been marked down to below its original selling price. This method is
often used in the retail industry for measuring inventories of rapidly changing items
that have similar margins.
• The percentage used takes into consideration inventory that has been marked down
to below its original selling price. An average percentage for each retail department is
often used.

  EXAMPLE 2: MEASUREMENT TECHNIQUES OF COST

Mars Fashions is a new luxury retail company located in Lajpat Nagar, New Delhi. Kindly
advise the accountant of the company on the necessary accounting treatment for the
following items:
(a) One of Company’s product lines is beauty products, particularly cosmetics such as
lipsticks, moisturizers and compact make-up kits. The company sells hundreds of
different brands of these products. Each product is quite similar, is purchased at
similar prices and has a short lifecycle before a new similar product is introduced.
The point of sale and inventory system is not yet fully functioning in this department.
The sales manager of the cosmetic department is unsure of the cost of each product
but is confident of the selling price and has reliably informed you that the Company,
on average, make a gross margin of 65% on each line.
(b) Mars Fashions also sells handbags. The Company manufactures their own handbags
as they wish to be assured of the quality and craftsmanship which goes into each
handbag. The handbags are manufactured in India in the head office factory which
has made handbags for the last fifty years. Normally, Mars manufactures 100,000
handbags a year in their handbag division which uses 15% of the space and overheads
 IND AS-2: VALUATION OF INVENTORIES 9

of the head office factory. The division employs ten people and is seen as being an
efficient division within the overall company.
In accordance with Ind AS 2, explain how the items referred to in a) and b) should be
measured.

SOLUTION

(a) The retail method can be used for measuring inventories of the beauty products. The
cost of the inventory is determined by taking the selling price of the cosmetics and
reducing it by the gross margin of 65% to arrive at the cost.
• The handbags can be measured using standard cost especially if the results approximate
cost. Given that The company has the information reliably on hand in relation to direct
materials, direct labour, direct expenses and overheads, it would be the best method
to use to arrive at the cost of inventories.

CONCEPT 9: INVENTORY ORDINARILY NOT INTERCHANGEABLE

The cost of inventories of items that are not ordinarily interchangeable and goods or
services produced and segregated for specific projects shall be assigned by using specific
identification of their individual costs. Specific identification of cost means that specific
costs are attributed to identified items of inventory.

CONCEPT 10: INVENTORY ORDINARILY INTERCHANGEABLE

• The costs of inventories, other than that are not ordinarily interchangeable and goods
or services produced and segregated for specific projects, shall be assigned by using
the first-in, first-out (FIFO) or weighted average cost formula.
• An entity shall use the same cost formula for all inventories having a similar nature
and use to the entity. For inventories with a different nature or use, different cost
formulas may be justified.
• FIFO formula assumes that the items of inventory that were purchased or produced
first are sold first, and consequently the items remaining in inventory at the end of the
period are those most recently purchased or produced.
• Under the weighted average cost formula, the cost of each item is determined from
the weighted average of the cost of similar items at the beginning of a period and the
cost of similar items purchased or produced during the period. The average may be
calculated on a periodic basis, or as each additional shipment is received, depending upon
the circumstances of the entity.
 10 IND AS-2: VALUATION OF INVENTORIES

Specific identification of Other items

items of inventory of inventory

Apply either:
Identified actual costs First-in-first out
Weighted Average

  EXAMPLE 3
Mercury Ltd. uses a periodic inventory system. The following information relates to 20X1-
20X2.

Date Particular Unit Cost p.u. Total Cost

April Inventory 200 10 2,000
May Purchases 50 11 550
September Purchases 400 12 4,800
February Purchases 350 14 4,900
Total 1,000 12,250

Physical inventory at 31.03.20X2 400 units. Calculate ending inventory value and cost of
sales using:
(a) FIFO
(b) Weighted Average

SOLUTION

FIFO inventory 31.03.20X2 350@ 14= 4,900

50 @ 12= 600
5,500
Cost of Sales 12,250-5,500= 6,750
Weighted average cost per item 12.250|1000= 12.25
Weighted average inventory at 31.03.20X2 400*12.25= 4,900
Cost of sales 20X1-20X2 12,250-4,900= 7,350
 IND AS-2: VALUATION OF INVENTORIES 11

CONCEPT 11: NET REALISABLE VALUE

Measurement of net realisable value

• Net realisable value is the estimated selling price in the ordinary course of business less
the estimated costs of completion and the estimated costs necessary to make the sale.
The cost of inventories may not be recoverable if those inventories are damaged, if they
have become wholly or partially obsolete, or if their selling prices have declined.
• Estimates of net realisable value are based on the most reliable evidence available at
the time the estimates are made, of the amount the inventories are expected to realise.
These estimates take into consideration fluctuations of price or cost directly relating
to events occurring after the end of the period to the extent that such events confirm
conditions existing at the end of the period.
• Estimates of net realisable value also take into consideration the purpose for which the
inventory is held. For example, the net realisable value of the quantity of inventory held
to satisfy firm sales or service contracts is based on the contract price. If the sales
contracts are for less than the inventory quantities held, the net realisable value of the
excess is based on general selling prices.
• Inventories are usually written down to net realisable value item by item. It is not
appropriate to write inventories down on the basis of a classification of inventory, for
example, finished goods, or all the inventories in a particular operating segment.

Writing inventories down to net realisable value

Materials and other supplies held for use in the production of inventories are not written
down below cost if the finished products in which they will be incorporated are expected to
be sold at or above cost. However, when a decline in the price of materials indicates that
the cost of the finished products exceeds net realisable value, the materials are written
down to net realisable value. In such circumstances, the replacement cost of the materials
may be the best available measure of their net realisable value.

CONCEPT 12: REVERSALS OF WRITE-DOWNS

• A new assessment is made of net realisable value in each subsequent period. When
the circumstances that previously caused inventories to be written down below cost
no longer exist or when there is clear evidence of an increase in net realisable value
because of changed economic circumstances, the amount of the write-down is reversed
(ie the reversal is limited to the amount of the original write-down) so that the new
carrying amount is the lower of the cost and the revised net realisable value.
• This occurs, for example, when an item of inventory that is carried at net realisable
value, because its selling price has declined, is still on hand in a subsequent period and
its selling price has increased.
 12 IND AS-2: VALUATION OF INVENTORIES

  EXAMPLE 4
Sun Pharma Limited, a renowned company in the field of pharmaceuticals has the following
four items in inventory: The Cost and Net realizable value is given as follows:

Item Cost Net Realisable Value

A 2,000 1,900
B 5,000 5,100
C 4400 4,550
D 3,200 2990
Total 14,600 14,540

Determine the value of Inventories:

a. On an item by item basis
b. On a group basis

SOLUTION
Inventories shall be measured at the lower of cost and net realisable value.

Item by item basis :

A 1,900
B 5,000
C 4,400
D 2,990
14,290
Group basis 14,540

CONCEPT 13 :DISCLOSURE
The financial statements shall disclose:

1) Accounting policies
the accounting policies adopted in measuring inventories, including the cost formula
used.
2) Analysis of carrying amount
the total carrying amount of inventories and the carrying amount in classifications
appropriate to the entity.
 IND AS-2: VALUATION OF INVENTORIES 13

Common classifications of inventories are as follows:

a) Merchandise;
b) Production supplies;
c) Materials;
d) Work in progress; and
e) Finished goods.
The inventories of a service provider may be described as work in progress
3) Inventories carried at fair value less costs to sell
the carrying amount of inventories carried at fair value less costs to sell.
4) Amounts recognised in profit or loss
a) the amount of inventories recognised as an expense during the period;
b) the amount of any write-down of inventories recognised as an expense in the
period; and
c) the amount of any reversal of any write-down that is recognised as a reduction in
the amount of inventories recognised as expense in the period.
In addition, disclosure is required of the circumstances or events that led to the
reversal of a write-down of inventories.
5) Inventories pledged as security
the carrying amount of inventories pledged as security for liabilities.
An entity adopts a format for profit or loss that results in amounts being disclosed
other than the cost of inventories recognised as an expense during the period. Under
this format, the entity presents an analysis of expenses using a classification based
on the nature of expenses. In this case, the entity discloses the costs recognised as
an expense for raw materials and consumables, labour costs and other costs together
with the amount of the net change in inventories for the period.
14 IND AS-2: VALUATION OF INVENTORIES

SIGNIFICANT DIFFERENCES IN IND AS VIS-À-VIS AS2

S.No. Particular Ind AS 2 AS2
1. Subsequent Ind AS 2 deals with the AS 2 does not provide the
subsequent recognition of same
cost/ carrying amount of
inventories as an expense
2. Inventory In AS 2 provides explanation AS 2 does not contain such an
of Service with regard to inventories of explanation
provider service providers
3. Machinery Ind AS 2 does not contain AS 2 explains that inventories
Spares specific explanation in respect do not include spare parts,
of such spares as this aspect servicing equipment and
is covered under Ind AS 16 standby equipment which meet
the definition of property,
plant and equipment, Plant and
Equipment. Such items are
accounted for in accordance
with Accounting Standard
(AS) 10, Property, Plant and
Equipment.
4. Inventory Ind AS 2 does not apply to This aspect is not there in the
held by measurement of inventories AS 2
Commodity held by commodity broker-
Broker- traders, who measure their
traders inventories at fair value less
costs to sell.
5. Definition Ind AS 2 defines fair value AS 2 does not contain the
of Fair and provides an explanation in definition of fair value and
Value and respect of distinction between such explanation.
Distinction ‘net realisable value’ and ‘fair
Between value’
NRV and Fair
Value
6. Subsequent Ind AS 2 provides detailed
Assessment guidance in case of subsequent
of NRV assessment of net realisable
value.
 IND AS-2: VALUATION OF INVENTORIES 15

It also deals with the

reversal of the write-down of
inventories to net realisable
value to the extent of the
amount of original write-
down, and the recognition
and disclosure thereof in the
financial statements.
7. Exclusion Ind AS 2 excludes from its AS 2 excludes from its scope
from its scope only the measurement such types of inventories.
Scope but of inventories held by
Guidance producers of agricultural and
given forest products, agricultural
produce after harvest, and
minerals and mineral products
though it provides guidance
on measurement of such
inventories.
8. Cost Ind AS 2 requires the use of AS 2 specifically provides
Formulae consistent cost formulas for that the formula used in
all inventories having a similar determining the cost of an
nature and use to the entity. item of inventory should
reflect the fairest possible
approximation to the cost
incurred in bringing the items
of inventory to their present
location and condition.
 16 IND AS-2: VALUATION OF INVENTORIES

UNSOLVED QUESTION

  QUESTION NO 1
State with reference to AS, how will you value the inventories in the following case. For
kilogram of Finished Goods consisted of Material cost Rs. 100 per kg. Direct Labour Cost Rs.
20 per kg. and Direct Variable Production Overhead Rs.10per kg. Fixed Production charges
for the year on normal capacity of 1,00,000 kg. is Rs.10 Lakhs. 2,000 kg. of Finished Goods
are on stock at the year end.

  QUESTION NO 2
Lambodar Ltd’s normal production volume is 50,000 units and the Fixed Overheads are
estimated at Rs. 5,00,000 Give the treatment of Fixed Production. OH under IND- AS-2
if actual production during a period was – (a) 42,000 units (b) 50,000 units and (c) 60,000
units.

  QUESTION NO 3
Vaiabh Industries produces four Joint Products L,M, N and P from a joint process, incurring
a cost of Rs. 571,200. Allocate the Joint Costs with the following information.

Particulars L M N P
Quantity Produced (in ‘000s) 10000 Kgs. 12000 Kgs. 14000 Kgs. 16000 Kgs.
Sales Price per Kg. Rs.13 Rs. 17 Rs.19 Rs.22
Stock Qty. at the end of year 1,625 Kgs. 400 Kgs. Nil 1,550 Kgs.

Also determine the value of Closing Stock in respect of the above products.

  QUESTION NO 4
In a manufacturing process of Mars ltd, one by-product BP emerges besides two main
products MP1 and MP2 apart from scrap. Details of cost of production process are here
under:

Item Unit Amount Output Closing Stock

31-3-20X1
Raw material 14,500 1,50,000 MP I-5,000 units 250
Wages - 90,000 MP II-4,000 units 100
Fixed overhead - 65,000 BP- 2,000 units
Variable overhead - 50,000
 IND AS-2: VALUATION OF INVENTORIES 17

Average market price of MP1 and MP2 is ` 60 per unit and ` 50 per unit respectively, by
- product is sold @ ` 20 per unit. There is separate processing charges of ` 8,000 and
packing charges of ` 2,000, ` 5,000 was realised from sale of scrap.
Required:
Calculate the value of closing stock of MP1 and MP2 as on 31-03-20X1.

  QUESTION NO 5
Closing Inventory at Cost of a Company amounted to Rs. 956,700. The following items were
included at cost in the total –

(a) 350 Shirts, which had cost Rs. 380 each and normally sold for Rs. 750 each. Owing to
a defect in manufacture, they were all sold after the Balance Sheet date at50% of
their normal price. Selling expenses amounted to 5% of the proceeds.
(b) 700 Trousers, which had cost Rs. 520 each. These too were found to be defective.
Selling expenses for the batch totaled Rs. 3800. They were sold for Rs. 950 each.
What should the inventory value be according to IND IND AS-2 after considering the
above items?

  QUESTION NO 6
A Ltd. produces chemical, X which has following production cost per unit.
Raw Material = Rs. 5
Direct Labor = Rs. 2
Direct Expenses = Rs. 3
Normal capacity = 5,00 units per annum
Actual production = 4,000 units
Fixed Production Overhead =Rs. 20,000 per annum.
The Company hIND AS-2,000 units of unsold stock lying with it at the end of year. You are
required to value the closing Stock.

  QUESTION NO 7
The Company incurred Rs. 20,00,000 as fixed production overhead per year. It normally
produces 1,00,000 units in a year. In 2009-10 how ever its production has been only 40,000
units. At the year end 31.3.2010 the closing stock was 10,000 units. The cost of unit is
below:
Material = Rs. 500 per unit
Labour = Rs. 250 per unit
 18 IND AS-2: VALUATION OF INVENTORIES

Fixed Production overhead = Rs. 20,00,000 p.a.

Fixed administration = Rs. 10,00,000 p.a.
Calculate the value of closing stock

  QUESTION NO 8
The Company deals in three products X, Y and Z, which are neither similar nor interchangeable.
at the time of closing of its account for the year 2001-2002. The historical cost and net
realizable values of the items of closing stock are determined as below:

Items Historical cost Net realizable value

(Rs. in Lakhs) (Rs.in Lakhs)
X 20 14
Y 16 16
Z 8 12
44 42

What will be the value of closing Stock?

  QUESTION NO 9
Y Ltd. purchased 500 units of raw material @ Rs. 150 per unit gross less 10% Trade discount
GST is chargeable @ 5% on the net price. The duty element on product is Rs. 12 per unit
against which CREDIT can be claimed. The company spent Rs. 1,000 on transportation and
Rs. 500 for loading and unloading Calculate the cost of purchase of raw material.

  QUESTION NO 10
XYZ Ltd produced 10,00,000 units of product A during 2009-10 per unit cost is as follows:
Raw Material Rs. 100
Direct Wages Rs. 50
Direct Expenses Rs. 2 
Rs. 152 

Production overhead is Rs. 20,00,000 of which 40% is fixed. The company sold 8,00,000
units and 2,00,000 units were in stock as on 31st March, 2010. Normal capacity is 5,00,000
units.
Calculate the value of closing stock
(Ans: Rs. 3.08 Crores)
 IND AS-2: VALUATION OF INVENTORIES 19

  QUESTION NO 11
Cost of Production of product X is given below:
Raw Material per unit Rs. 120
Wages per unit Rs. 80
Overhead per unit Rs. 50 
Rs. 250 
As on the balance sheet date the replacement cost of raw material is Rs. 110 per unit There
were 1000 units of raw material on 31.3.2011.
Calculate the value of closing stock of raw material in following conditions.

(a) If finished product is sold at the rate of Rs.275 per unit, what will be value of closing
stock of raw material.
(b) If finished product is sold at the rate of Rs.230 per unit, what will be value of closing
stock of raw material.

  QUESTION NO 12
A company does not value it’s W.I.P. because the quantity of work-in-progress cannot be
determined accurately and in any case, there is not much variation between the opening and
closing W.I.P. quantities. Comment on the above statement of the company.
Ans: Statement of company is not in accordance with IND AS-2.

  QUESTION NO 13
JATIN Ltd. purchased raw materials for 1,25,000 less a rebate of 2%. It paid 25,000 as
import duty, including ` 10,000 towards a special duty. According to local tax laws, it will
get a credit of the amount paid towards the special duty, while determining its customs
liability. It spent ` 8,000 on ocean freight, clearing agent’s charges of 2,000, 4,000 on
warehouse rent and 1,500 on the watchman’s salary.

  QUESTION NO 14
Per kg. of finished goods consisted of:
Material cost Rs 100 per kg.
Direct labour cost 20 per kg.
Direct variable production overhead 10 per kg.
Fixed production charges for the year on normal capacity of one lakh kg. is 10 lakhs. 2,000
kg. of finished goods are on stock at the year end. Calculate value of inventories.
 20 IND AS-2: VALUATION OF INVENTORIES

  QUESTION NO 15
Total Unit : 10,000 (closing stock)
Contract sales : 6,000 units
Normal units : 4,000 units
Cost per unit : 150
Contract selling price : 200
Market Price : 90

  QUESTION NO 16 (VALUATION OF WIP)

On 31St March, 2013 a business firm finds that cost of a partly finished unit on that date is
530. The unit can be finished in 2013-14 by an additional expenditure of 310. The finished
unit can be sold for 750 subject to payment of 4% brokerage on selling price. The firm
seeks your advice regarding:

(i) The amount at which the unfinished unit should be valued as at 31st March, 2013 for
preparation of final accounts and
(ii) The desirability or otherwise of producing -the finished unit.
 IND AS-2: VALUATION OF INVENTORIES 21

SOLVED QUESTIONS FOR SELF PRACTICE

  QUESTION NO 17
Grow More Private Limited a Wholesaler in Food and Other Agro Products has valued the
year-end Inventory of Net Realizable Value on the ground that IND IND AS-2 does not
apply to inventory of Agriculture Products Comment.

SOLUTION

1. Principle: IND IND AS-2 does not apply to Producers Inventories of Livestock, Forest
Product and Mineral Ores and Gases. These can be valued at Net Realizable value as
per established practices.
2. Analysis and Conclusion:
(a) However, the above principle does not apply in Trader’s Inventory of Food and
Agro Products. In the above case, Grow More Ltd. is only a Trader (Wholesaler)
and not the producer. Hence, they cannot value their inventory at Net Realizable
Value.
(b) As IND IND AS-2, the Company should value the Inventory at lower of cost or
Net Realisable Value. If the Management of M/s. Grow More Ltd. does not agree,
the Auditor should qualify the Report.

  QUESTION NO 18
Varada Ltd. purchased goods at the cost of Rs. 40 Lakhs in October. Till the end of the
Financial year, 75% of the Stocks were sold. The Company wants to disclose Closing
Stock at Rs. 10 Lakhs. The expected Sale value is Rs. 11 Lakhs and a commission at 10% on
sale is payable to the Agent. What is the correct value of Closing Stock.

SOLUTION
Principle: Inventories are valued at – (a) Cost or (b) Net Realisable Value, whichever is lower.

Particulars Amount (Rs.)

1. Cost Inventory (Rs. 40 Lakhs x 25% Unsold) 10.00 Lakhs
2. NRV (Expected Sales Value Rs.11 Lakhs Less cost to make the sale 9.90 Lakhs
10% Rs. 1.10 Lakh)
3. Value of Inventory under IND AS-2 = Least of the above 9.90 Lakhs

  QUESTION NO 19
Gajanan Ltd. manufacturing garments and fancy terry towels has valued at the year end,
its Closing Stock of Inventories of Finished Goods, (for which firm contracts have been
 22 IND AS-2: VALUATION OF INVENTORIES

received and goods are packed for export, but the ownership of which has not been
transferred to the foreign buyers) at the Realisable Value inclusive of Profit and the
export cash Incentives. Give your views on the above.

SOLUTION

1. General Principle: IND IND AS-2 requires that inventories should be valued at lower
of cost and NRV. A departure from the general principle can be made if – (a) the
AS is not applicable, or (b) having regard to the nature of industry say, plantations,
inventories may be valued at market prices or price subsequently realized.
2. Special Items (Para 2): IND IND AS-2 also states that Producers’ Inventories of
Livestock, Agriculture Crops, etc. are measured at NRV based on established practices
if – (a) sale is assured under a Forward Contract or a Government Guarantee, or (b)
where market is homogenous, and there is a negligible risk of failure to sell.
3. Analysis: In the given case the sale is assured under a Forward Contract but the goods
are not of a nature covered by exceptions under Para 2. Hence, the Closing Stock
of Finished Goods should have been valued at cost, as it is lower than the realizable
value (as it includes profit). Also, Export Cash Incentives should not be included for
valuation purposes.
4. Conclusion: Hence, the Company’s policy of valuation is not correct.

  QUESTION NO 20
Akshay Pharma Ltd. ordered 16,000 kg. of certain material at Rs. 160 per unit. The
Purchase Price includes GST Rs. 10 per kg. in respect of which full GST Credit is admissible.
Freight incurred amounted to Rs. 1,40,160. Normal Transit Loss is 2%. The Company
actually received 15,500 kg. and consumed 13,600 kg. of Material. Compute the Cost of
Inventory under IND IND AS-2 and the amount of Abnormal Loss.

SOLUTION

1. Quantity Reconciliation:
Total Purchase Quantity (given) = 16,000 kg.
Normal Loss 2% on 16,000 = 320 kg.
Balance Effective Quantity = 16,000 (-) 320 = 15,680 kg.
Actually Received (given) = 15,500 kg.
Balance Abnormal Loss 15,680 (-) 15,500 = 180 kg.
Consumption Quantity (given) = 13,600 kg.
Closing Stock (bal.fig) = 15500 (–) 13,600 = 1900 kg.
 IND AS-2: VALUATION OF INVENTORIES 23

2. Computation of Effective Cost per kg.

Particulars Rs.
Net Cost Per unit (excluding GSTfor which Credit is available) 150
Total Purchase Cost for 16,000 kg. ordered 24,00,000
Add: Freight Charges 1,40,160
Total Cost of Inventory 25,40,160
Effective Quantity ()i.e. Gross Ordered Quantity Less Normal 15,680 Kg.
Loss) = 16,000 (-) 320 =
Effective Cost Per Kg. Rs. 25,40,160/15,680 Rs. 162.00

3. Valuation of Inventory and Abnormal Loss

Particulars Rs. Treatment

(a) Cost of Material Consumed 22,03,200 Shown in Income Statement
= 13,600 Kg. at Rs.162 as Expense

(b) Cost of Abnormal Loss 29,160 Shown in Income Statement

= 180 Kg. at Rs.162 as Expense/Loss

(c) Cost of Closing Stock 3,07,800 Shown in Balance Sheet

= 1,900 Kg. at Rs.162

Note: Claim, if any, from Insurance Company will be set off against the cost of
Abnormal Loss as shown above.

  QUESTION NO 21
In a production process, normal waste is 5% of input, 5,000 MT of input wee put in
process resulting in a wastage of 300 MT. Cost per MT of input is Rs. 1,000. The entire
quantity of waste is on stock at the year – end. State with reference to how you will value
the inventories in the above case.

SOLUTION
1. Principle: Abnormal Amounts of Waste Materials, Labour or other Production Costs
are excluded from cost of inventories and such costs are recognized as expenses in
the period in which they are incurred.
2. Analysis and Conclusion: In this case, Normal Waste is 5% of 5000 MT = 250 MT and
Abnormal Waste is 300 MT (-) 25% MT = 50 MT.
(a) Cost of Normal Waste 250 MT will be absorbed and included in determining the
cost of inventories (Finished Goods) at the year end.
 24 IND AS-2: VALUATION OF INVENTORIES

(b) Cost of Abnormal Waste = Rs. 52631 (50 MT x Rs. 1,052) will be charged in the
P&L Statement.

  QUESTION NO 22 (INTEREST ON BANK OVERDRAFT)

Can PT Ltd. a Wire Netting Company, while valuing its Finished Stock at the year end
include interest on Bank Overdraft as an element of cost, for the reason that Overdraft
has been taken specifically for the purpose of financing Current Assets like Inventory and
for meeting day to day working expenses?

SOLUTION

1. Nature of Interest: As per IND IND AS-2, “Interest and other Borrowing Costs are
usually considered as not relating to bringing the inventories to their present location
& condition, and hence usually, excluded in the cost of inventories”.
2. Qualifying Assets: IND IND AS-23 identifies inventories which require a substantial
period of time to bring them to a saleable condition as a Qualifying Assets, and permits
capitalization of borrowing costs directly attributable to the asset as part of the Cost
of the Asset.
3. Conclusion: In the given case, PI Ltd. can capitalize the interest cost on Bank
Overdraft, only if its Inventories are is the nature of a Qualifying Asset as per IND
IND AS-23. Otherwise, the entire amount will be treated as expense.

  QUESTION NO 23
From the following data, find out value of Inventory as on 30th April using (a) LIFO Method,
and (b) FIFO Method –
(a) Purchased on 1st April 10 units at Rs. 70 per unit
(b) Sold on 6th April 6 units at Rs. 90 per unit
(c) Purchased on 9th April 20 units at Rs. 75 per unit
(d) Sold on 18th April 14 units at Rs. 100 per unit

SOLUTION

1. Closing Stock (in Units) : 10 (-) 6 + 20 (-)14 = 10 units.

2. Valuation :

Value of Inventory under LIFO Basis Value of Inventory under FIFO Basis
4 units from 1st April – 4 x Rs.70 = Rs.280 10 Units from 9th April – 10 x Rs.75 = Rs.750
6 units from 9th April – 6 x Rs.75 = Rs.450 Total Cost = Rs. 750
Total Cost = Rs. 730
 IND AS-2: VALUATION OF INVENTORIES 25

  QUESTION NO 24
In order to value the inventory of Finished Goods HR Ltd. has adopted the Standard Cost
of Raw Materials, Labour and Overheads. The Income Tax Officer wants to know the
method, as per IND IND AS-2 for the valuation of Raw Material. Comment.

SOLUTION

1. The use of Standard Cost of Production has been suggested by IND IND AS-2 as a
matter of convenience only. IND IND AS-2 suggests that Standard Cost system may
be used for convenience if the results approximate the actual cost.
2. For Inventory Valuation, IND IND AS-2 recognises the use of absorption costing based
on normal capacity. If the Company can adopt absorption costing for value of inventory,
then the Standard Cost system need not be adopted.

  QUESTION NO 25
HP is a leading distributor of Petrol. A detail Inventory of Petrol in hand is taken when
the books are closed at the end of each month. At the end of the month, the following
information is available.
Sales – Rs. 47,25,000, General Overheads Cost – Rs. 1,25,000, Inventory at beginning
– 1,00,000 Litres at Rs. 15 per Litre.
Purchases: (a) June 1 Two Lakh Litres at 14.25 (b) June 30 One Lakh Litres at 15.15 (c)
Closing Inventory 1.30 Lakh Litres Compute the following by the FIFO as per IND IND
AS-2.
(a) Value of Inventory on June 30.
(b) Amount of Cost of goods sold for June.
(c) Profit/Loss for the month of June.

SOLUTION

1. Value of Inventory as on June 30:

Particulars Rs.
0.30 Lakh Litres from June 1 Purchase Lot 4,27,500
(0.30 Lakh Litres x Rs.14.25 Per Litre)
1 Lakh Litres from June 30 Purchase Lot 15,15,000
(1 Lakh Litres x Rs.15.15 Litre)

Value of Inventory s on June 30 19,42,500

 26 IND AS-2: VALUATION OF INVENTORIES

2. Cost of Goods Sold:

Particulars Rs.
Opening Stock (1 Lakh Litres x Rs.15) 15,00,000
Add: Purchases (2 Lakh Litres x Rs.14.5) + (1 Lakh Litres x Rs.15.15) 43,65,000
Less: Closing Stock 19,42,000

Cost of Goods Sold 39,22,500

3. Profit/Loss for June:

Sales (Rs. 47,25,000) – Cost of Goods Sold (Rs.39,22,500) – General Overheads Cost
(Rs. 1,25,000) = Profit Rs. 6,77,500

  QUESTION NO 26 (RETAIL VALUE WITH WEIGHTED AVERAGE)

Shri Ganesh operates a retail business. For a financial year, the following data is given -

Particulars At Retail Price At cost

Value of Opening Inventory Rs. 80,000 Rs. 60,000
Value of Purchases Rs. 1,40,000 Rs. 1,20,000

Calculate the cost of Closing Stocks, if the Sales made during the period is Rs.2,00,000
(APPLY WEIGHTED AVERAGE METHOD)

SOLUTION

Value of Closing Inventory at Retail = Opening Stock + Purchases (-) Sales

Prices = Rs. 80,000 + Rs. 1,40,000 (-) Rs. 2,00,000
= Rs. 20,000
Average Percentage of Cost to Retail Total Average Cost
=
Prices Total Average Retail Value

60,000 + 1,20,000
= = 81.82%
80,000 + 1,40,000

Value of Closing Inventory at Cost = Retail values Less Margin of 18.18%

Prices = Rs.20,000 (-) 18.18% thereon
= Rs.16,364.

  QUESTION NO 27 (APPLICATION OF NRV)

Inventories of a Car Manufacturing Company include the value of items, required for the
 IND AS-2: VALUATION OF INVENTORIES 27

manufacture of a model, which was removed from the production line five years back, at
Cost Price. As an Auditor, give your comments.

SOLUTION

1. IND IND AS-2 provides that the cost of inventories may not be recoverable if those
inventories which are damaged, have become partially/fully obsolete, or if their selling
prices have declined.
2. The Auditor should examine whether appropriate allowance has been made for the
defective/obsolete/damaged inventories in determining the NRV. Having regard to
this, NRV of inventory items, whichever was removed from the production line 5 years
back, is likely to be much lower than the cost, as shown in the books of account. Thus,
it becomes necessary to write down the inventories to NRV.
3. Since the Company has valued these inventories at cost, it has resulted in over
statement of inventory and profits. Hence, the Auditor should qualify his report.

  QUESTION NO 28 (VALUATION OF INVENTORY)

Best Ltd. deals in 5 products – P Q, R, S & T which are neither similar nor interchangeable.
While closing its accounts for the year ending 31st March, the Historical Cost and NRV of
the items of Closing Stock are determined as follows:-

Items P Q R S T
Historical Cost (Rs.) 5,70,000 9,80,000 4,25,000 4,25,000 1,60,000
Net Realizale Value (Rs.) 4,75,000 10,32000 2,89,000 4,25,000 2,15,000

What is the Value of Closing Stock for the year ending 31st March as per IND IND AS-27.
Note: Refer Principle relating to item-by-item write-down given above.

SOLUTION
In the given case, since Inventories are not interchangeable, they are to be valued
independently.

Item Historical Cost (Rs.) NRV (Rs.) Valuation (Rs.) = Least of (2) or (3)
P 5,70,000 4,75,000 4,75,000
Q 9,80,000 10,32,000 9,80,000
R 3,16,000 2,89,000 2,89,000
S 4,25,000 4,25,000 4,25,000
T 1,60,000 2,15,000 1,60,000
Inventory Value = 23,29,000
 28 IND AS-2: VALUATION OF INVENTORIES

  QUESTION NO 29 (VALUATION OF RAW MATERIAL)

A Raw Material costing Rs. 150 has Net Realisable Value (which can be the Replacement
Cost) Rs.130. The Finished Goods for which this Raw Material is used, has other cost to
incur Rs.60. At what Price should the Raw Material be valued, if Finished Goods has a Net
Realizable Value – (1) Rs. 210 or above (2) less than Rs. 190

SOLUTION
Note: In all cases given above Cost of Finished Goods (RM at actuals 150+ Conversion 60)
= Rs. 210.

1. SP Rs. 210 or above: If Sale Price is Rs. 210 or above the cost of FG can be
recovered/realized fully. Hence, there is no need to write down RM Inventory to Rs.
130. So, Raw Material will be valued at Rs. 150.
2. SP less than Rs.190: In this case, since cost of finished goods is not realizable fully,
the Raw Material Inventory should be written down to Replacement Cost, i.e. Rs.130

  QUESTION NO 30 (VALUATION OF WIP)

On 31st March, a Business Firm finds that cost of a partly finished unit on that date is
Rs.530. The unit can be finished in its next financial year, by an additional expenditure of
Rs. 310. The Finished Unit can be sold for Rs.750 subject to payment of 4% brokerage on
Selling Price The firm seeks your advice regarding -

(a) The amount at which the unfinished Unit should be valued as at 31st March for
preparation of Final Accounts, and
(b) The desirability or otherwise of producing the Finished unit.
SOLUTION

Particulars Amount
1. Estimated Net Realisable Value of Final Product
= Sale value 750 less 4% Brokerage 30 less Further
Processing Costs 310 = 750 – 30 – 310 410

2. Actual Cost incurred till date on the partly finished unit 530
(including RM cost therein)

3. Since the entire actual cost of Rs.530 is not recovered by use in finished 530 - 410
production, the partly finished unit should be valued at its value in use, = 120
i.e. NRV Rs.410. So Inventory should be written down by

4. Considering actual costs till date Rs.530 + additional expected cost

Rs. 310 it is not worthwhile to process this item further.
 IND AS-2: VALUATION OF INVENTORIES 29

  QUESTION NO 31 (VALUATION OF RAW MATERIAL)

Hari Ltd. purchased Raw Material at Rs. 400 per kg. The Company does not sell Raw
Material but uses it in the production of Finished Goods. The Finished Gods in which Raw
Material is used are expected to be sold at below cost. At the end of the accounting year,
the Company is having 10,000 kg. of Raw Material in Stock as the Company never sells the
Raw Material, does not know the Selling Price of Raw Material and hence cannot calculate
the Realizable Value of the Raw Material for valuation of Inventories at the end of the
year. However, Replacement cost of Raw Material is Rs.300 per kg. How will you value the
Inventory of Raw Material?

SOLUTION
Hint: Refer principle relating to RM valued at NRV given above.
Inventory should be valued at Replacement Cost of 10,000 Kgs. x Rs.300 per Kg.
= Rs. 30,00,000

  QUESTION NO 32
A company is engaged in the manufacturing of organic chemicals Production of one
intermediate product (say X) is in excess of its immediate requirement for captive
consumption. Further factors are:
(i) X is not marketable and therefore, the market price is not known.
(ii) The estimated expenditure the further processing of X is Rs. 6000 per ton.
(iii) The company has been valuing the stock of X by theoretically converting it into
equivalent units of finished products and then valuing the same on the principle of
cost or net realizable value, whichever is lower.
Comments:
(a) Whether the present practice of valuating the X at the lower of cost and net
realizable value of the end-product by theoretically converting it into equivalent
finished product is in order.
(b) Whether the company can value at cost the stock X since X will have to undergo
further processing to become marketable and net realizable value of X in its present
form cannot be ascertained.
(c) If the answer of above (a) & (b) is negative, suggest the correct method for
valuation of X.

ANSWER:
(a) NO
(b) NO – If net realizable after processing of X is ascertainable.
(c) At cost
 30 IND AS-2: VALUATION OF INVENTORIES

  QUESTION NO 33
Capital Cables Ltd. has normal wastage of 4% in the production process. During the year
2013-14 the Company used 12,000 MT of Raw Material costing Rs.150 per MT. At the end
of the year 630 MT of Wastage was in Stock. The Accountant wants to know how this
wastage is to be treated in the books. Explain in the context of IND AS-2 the treatment
of Normal Loss and Abnormal Loss and also find out the amount of Abnormal Loss if any.

SOLUTION

1. Principle: Abnormal Amounts of Waste Material, Labour or other Production costs are
excluded from cost of inventories and such costs are recognized as Expenses in the
period in which they are incurred.

2. Analysis and Conclusion: Normal Waste is 4% of 12,000 MT = 480 MT & Abnormal

Waste is 630 MT (-) 480 MT = 150MT.
(a) Cost of Normal Waste 480 MT wil be absorbed in the cost of Production and
included in determining the Cost of Inventories (Finished Goods) at the year end.
(b) Cost of Abnormal Waste will be charged in the Profit and Loss Statement.

3. Computation
12,000 MT x Rs. 150
(a) Effective Material Cost of Output =
12,000 MT – 4% Normal Waste
18,00,000
=
11,520
= Rs.156.25 Per MT
(b) Cost of Abnormal Waste = 150 MT x Rs.156.25 = Rs.23,437.50

  QUESTION NO 34
Calculate the value of Raw Materials and Closing Stock based on the following information:

Particulars Raw Material X Particulars Finished Goods Y

Closing Balance 500 Units Closing Balance 1200 Units
Cost Price including GST Rs.200 per unit Material Consumed Rs.220 per unit
GST (GST Credit is Direct Labour Rs. 60 per unit
receivable on GST paid) Rs.10 per unit Direct Overhead Rs. 40 per unit
Freight Inward Rs.20 per unit
Unloading Charges Rs.10 per unit
Replacement Cost Rs.150 per unit
 IND AS-2: VALUATION OF INVENTORIES 31

Total Fixed Overhead for the year was Rs. 2,00,000, on normal capacity of
20,000 units.
Calculate the value of the Closing Stock when –
(i) Net Realizable Value of the Finished Goods Y is Rs.400
(ii) Net Realizable Value of the Finished Goods Y is Rs.300

SOLUTION

1. Principle:
(a) Raw Materials and Supplies held for use in production are valued at cost. However,
they can be valued below cost (i.e. NRV) in the following peculiar situations.
• S
 ale below cost : When the Finished Products in which the Raw Material is
incorporated, are expected to be sold below cost.
• P
 rice Decline : When there is a decline in the price of materials, and it is
estimated that the cost of Finished Goods will be exceed NRV.
(b) Finished Goods will be valued at Cost (or) Net Realisable Value, whichever
is lower.

2. Valuation of Finished Goods Stock: In the given case the Valuation of FG Stock will
be as under:-
(a)
Cost per unit of Finished Goods:
(Material +Direct Labour + Direct Overhead + Fixed Production OH)
2,00,000
= 220 + 60 + 40 +
20,000

= Rs.330 per unit

(b) Valuation of FG will be –

Particulars If NRV is rs.400 p.u. If NRV is rs.300 p.u.

Value p.u. (Lower of 330 300
cost Rs.330 & NRV)
Total Value of Finished Rs. 330 x 1200 units Rs. 300 x 1200 units
Goods Stock = Rs. 3,96,000 = Rs. 3,60,000

3. Valuation of Raw Material Stock:

In the given case, the Valuation of RM Stock will be as under:-
 32 IND AS-2: VALUATION OF INVENTORIES

(a) Cost p.u. of Raw Material:

Particulars Cost p.u.

Purchase Price net of Excise Duty 190
(since GST Duty eligible for GST Credit) 200-10
Add: Freight Charges 20
Add: Unloading cost p.u. 10
Total Cost p.u. 220

(b) Total Value of Raw Material Closing Stock:

Particulars Finished Goods of Finished Goods of

valued at Cost valued at NRV
* Raw Material cost p.u. Rs. 220 Rs. 220
* Replacement cost p.u. Rs. 150 Rs. 150
* Relevant Value p.u. Rs. 229 (since FG is Rs. 150 (since FG is
valued at Cost) valued NRV)
* Total value for 500 units 500 x Rs.220 500 x Rs.150
= Rs.1,10,000 = Rs. 75,000

Note: Replacement Cost of the Raw Material is assumed as its Net Realisable
value.

  QUESTION NO 35
Mr. Mehul gives the following information relating to items forming part of inventory as
on 31.03.2015. His Factory produces Product X using Raw Material A.
1. 600 units of Raw Material A (Purchased at Rs.120). Replacement Cost of Raw
Material A as on 31.03.2015 is Rs. 90 per unit.
2. 500 units of Partly Finished Goods in the process of producing X and Cost incurred
till date Rs.260 per unit. These units can be finished next year by incurring
Additional Cost of Rs. 60 per unit.
3. 1,500 units of Finished Product X and Total Cost incurred Rs. 320 per unit.
Expected Selling price of Product X is Rs. 300 per unit.
Determine how each item of inventory will be valued on 31.03.2015. Calculate the Value of
Total Inventory as on 31.03.2015.
 IND AS-2: VALUATION OF INVENTORIES 33

SOLUTION

Item Valuation Principle Result

Raw Material Since the Finished Product using this Raw Material 600 x Rs. 90
is expectable be sold below cost, Raw Material may = Rs. 54000
be valued of NRV, i.e. Replacement cost of Rs.90.
WIP • Cost Rs. 260 500 x Rs. 240
• Estimated NRV = Rs. 1,20,000
= Sale Price Rs.300 – Cost to Complete Rs. 60
= Rs.240
• Hence, valued at least of the above, i.e. Rs.240
p.u.
Finished Cost Rs.320 or Net Realisable Value Rs.300, 1500 x Rs. 300
Goods whichever is lower. Hence valued at Rs.300 p.u. = Rs. 4,50,000
Total Rs. 6,24,000

  QUESTION NO 36
From the following information, value the Inventories as on 31st March, 2015.
Raw Material has been purchased at Rs.125 per Kg. Prices of Raw Material are on the
decline. The Finished Goods being manufactured with the Raw Material is also being sold
at below Cost. The Stock of Raw Material is of 15,000kg. and the Replacement Cost of
Raw Material is Rs.100 Per Kg.
Cost of Finished Goods per Kg. is as under:-

Particulars Rs. per Kg.

Material cost 125
Direct Labour Cost 20
Direct Variable Production Overhead 10

Fixed Production Overhead for the year for a normal capacity of 1,00,000 kgs. of
production is rs.10 Lakhs. At the year end, there were 2,000 Kgs. of Finished Goods in
stock. Net Realisabale value of Finished gods is rs.140 Per Kg.
 34 IND AS-2: VALUATION OF INVENTORIES

SOLUTION

1. Conversion Cost Per Kg. of Finished Product

= Direct Labour + Direct Variable Production OH + Fixed Production OH
Rs. 10 Lakhs
= Rs. 20 + Rs. 10 + = Rs. 40 Per Kg.
1 Lakh Kgs.

2. Inventory Valuation is as under:-

(A) For Finished Goods

(a) Cost per Kg. for Finished Product 125 + 40 = Rs. 165 Per Kg.
= Material + Conversion
(b) Net Realizable value of Finished Product if Given = Rs. 140 per kg.
sold after Conversion
(c) Hence, Valuation Rate for finished goods Rs. 140 Per kg.
= (a) or (b), whichever is lower.
(d) Value of Inventory 2,000 kg. of Finished 2,000 Kg. x Rs. 140
Product = Rs. 2,80,000

(B) For Raw Materials

(a) Cost of Raw Material Given = Rs. 125 Per kg.

(b) Replacement Cost of Material, i.e. Sale Given = Rs.100 Per Kg.
without Conversion
(c) Valuation Rate for Raw Material (i.e. least o Rs. 100 per Kg.
Cost or NRV, least of (a) and (b)
(d) Value of Inventory 15,000 kg. of Raw Material 15,000 kgs x Rs. 100
= Rs. 15,00,000

Note: When the Finished Products in which the Raw Material is incorporated, are expected
to be sold below Cot (NRV rs.140 Vs. Cost Rs.165), it is preferable to sell the product
without Conversion. In such case, the Raw Materials will be valued below cost, i.e. at NRV,
being the Replacement cost.

  QUESTION NO 37
Inventories of a Car manufacturing company include the value of items, required for the
manufacture of model which was removed from the production line five years back, at cost price.
As an Auditor Comment.
 IND AS-2: VALUATION OF INVENTORIES 35

ANSWER:

(1) Provision of IND AS-2

The cost of inventories may not be recoverable if those inventories are damaged,
have become wholly or partially obsolete, or if their selling prices have declined.
Accordingly, the auditor should examine whether appropriate allowance has been made
for the defective, damaged, obsolete and slow-moving inventories in determining the
net realizable value.

(2) Analysis and Conclusion

In this case, items required be the manufacture of a model which has been withdrawn
from the production line five veal’s ago are included in the stock at cost price resulting
in overstatement of inventory and profit. As it appears from the facts given that the
net realizable value of these items is likely to much lower than the cost at which these
are being shown in the books of account. Accordingly, it becomes necessary to write
down the inventory to ‘net realizable value’ if the items of inventories become wholly
or partially obsolete. Under the circumstance, the auditor should qualify the report
appropriately.

  QUESTION NO 38
The management tells you that the WIP is not valued since it is difficult to ascertain the
same, in view of the multiple processes involved and in any case, the value of opening and
closing WIP would be more or less the same. Advise.

ANSWER:

(i) Provision of IND AS-2

Inventory includes raw material, work-in-progress and finished goods and should
be valued at cost or NRV whichever is lower.

(ii) Analysis and Conclusion

In this case work-in-progress is also a component of inventory and should be valued
at cost or NRV whichever is lower.

  QUESTION NO 39
CC Ltd. a Pharmaceutical Company, while valuing its finished stock at the year end wants to
include interest on Bank Overdraft as an element of cost, for the Reason that overdraft
has been taken specifically for the purpose of financing curl-cut assets like inventory and
for meeting day to day working expenses.
 36 IND AS-2: VALUATION OF INVENTORIES

ANSWER:

(i) Provision of IND AS-2

Cost of inventories comprises all costs of purchase, costs of conversion and other costs
incurred in bringing the inventories to their present location and condition. However,
it makes clear that interest and othet- borrowing costs are usually not included in
the cost of inventories because generally such costs at-c not related in bringing the
inventories to their present location and condition.

(ii) Conclusion
Therefore, the proposal of CC Ltd. to include interest on bank overdraft as an element
of cost is not acceptable because it does not form part of cost of production.

  QUESTION NO 40
A company is engaged in the manufacture of electronic products and systems. As per Chief
Accountant a prototype system was installed at one of the customer’s locations in June
2010 for getting acceptance on the performance of the system. The Chief Accountant has
stated that as the ownership of the system installed for field trials was vested with the
company, for accounting & control purposes, the prototype system installed at customer’s
location in 2010 was capitalised in the accounts for the year 20 10-1 1 at its bought-out
cost. State whether the accounting treatment adopted by the company is correct or not?

ANSWER:

(i) Provision of IND AS-2

Inventories mean assets held for sale in the ordinary course of business, or in the
process of production for such sale, or for consumption in the production of goods or
services for sale, including maintenance supplies and consumable other than machinery
spares.

(ii) Provision of IND AS 16

Fixed asset is an asset held with the intention of being used for the purpose of
producing or providing goods or services and is not held for sale in the normal course
of business.

(iii) Analysis and Conclusion

Accordingly, the system installed by the company at customer’s site for his acceptance,
based on the field trials of the system, is an item of inventory, it is not a fixed assets.
installation of such prototype system at customer’s sites for their acceptance is akin
to sale of goods on approval basis. Therefore, the capitalization of such prototype
system at its bought out cost is not correct.
 IND AS-2: VALUATION OF INVENTORIES 37

  QUESTION NO 41
(Study Material) Ambica Stores is a departmental store, which sell goods on retail basis.
It makes a gross profit of 20% on net sales. The following figures for the year-end are
available:
Opening Stock Rs. 50,000
Purchases Rs. 3,60,000
Purchases Returns Rs. 10,000
Freight Inwards Rs. 10,000
Gross Sales Rs. 4,50,000
Sales Returns Rs. 11,250
Carriage Outwards Rs. 5,000
Compute the estimated cost of the inventory on the closing date.

ANSWER:
Calculation of Cost for Closing Stock

Particulars Rs
Opening Stock 50,000
Purchase less return ( 3,60,000-10,000) 3,50,000
Freight Inwards 10,000
4,10,000
Less:COGS ( 4,50,000 -11,250) – profit @ 20% 3,51,000
Closing Stock 59,000

  QUESTION NO 42 (STUDY MATERIAL)

Particular Kg. Rs
Opening Stock: Finished Goods 1,000 25,000
Raw Materials 1,100 11,000
Purchase 10,000 1,00,000
Labour 76,500
Overhead (Fixed ) 75,000
Sales 10,000 2,80,000
Closing Stock: Raw Materials 900
Finished Goods 1,200
 38 IND AS-2: VALUATION OF INVENTORIES

The expected production for the ‘year was 15,000 kg. of the finished product. Due to fall
in market demand the sales price for the finished goods 20 per kg. and the replacement
cost for the raw metatarsal was 9.50 per kg. n the closing day. You are required to
calculate the closing stock as on that date.

ANSWER:

(i) Calculation of Cost per Unit

Particulars Rs
Raw Material consumed (1100 + 10000 - 900) @10 per unit 1,02,000
Director Labour 76,500
Fixed Overhead 51,000

Cost of production 2,29,500

Cost of closing stock per unit ( 2,29,500 10,200) 22.50

(ii) Conclusion
Since NRV is lower than cost hence Finished goods is valued at 20 i.e. NRV and raw
material is valued at replacement cost i.e. 9.5.
Finished Goods (1,200 × 20) 24,000
Raw Materials (900 × 9.50) 8,550
32,550

  QUESTION NO 43
The closing inventory at cost of a company amounted to 2,84,700. The following items
were included at cost in the total:
(a) 400 coats, which had cost 80 each and normally sold for 150 each. Owing to a
defect in manufacture, they were all sold after the balance sheet date at 50%of
their normal price. Selling expenses amounted to 5% of the proceeds.
(b) 800 skirts, which had cost 20 each. These too were found to be defective. Remedial
work in April cost 5 per skirt, and selling expenses for the batch totalled800. They
were sold for 28 each.
What should the inventory value be according to IND AS-2 after considering the above
items?
 IND AS-2: VALUATION OF INVENTORIES 39

ANSWER:
Valuation of Closing Stock

Particulars Rs Rs
Closing Stock at Cost 2,84,700
Less: Cost of 400 coats ( 400x 80) 32,000
Less: Net Realisable Value (400 X 75) - 5% (28,500) (3,500)
Value of closing Stock 2,81,200

Note: There is no loss on skirts due to which we have not considered any decline.

  QUESTION NO 44
Best Ltd. deals in Five Products - P, Q, R, Sand T which are neither similar nor
interchangeable. At the time of closing of its Accounts for the year ending 31St March
2011, the Historical Cost and Net Realizable Value of the items of the Closing Stock are
determined as follows :-

Items Historical Cost (R) Net Realizable Value (R)

P 5,70,000 4,75,000
Q 9,80,000 10,32,000
R 3,16,000 2,89,000
S 4,25,000 4,25,000
T 1,60,000 2,15,000

What will be the Value of Closing Stock for the year ending 31St March 2011 as per IND
AS-2 “Valuation of Inventories”?

ANSWER:
Statement of Valuation of Inventory

Particulars Rs
Item P 4,75,000
Item Q 9,80,000
Item R 2,89,000
Item S 4,25,000
Item-T 1,60,000
Total 23,29,000
 40 IND AS-2: VALUATION OF INVENTORIES

  QUESTION NO 45
XY Ltd. was making provisions for non-moving stocks based on no issues for the last
L2 months upto 31.3.11. Based on technical evaluation the company wants to make
pmvsionsTuring year 3 1.3.12.
Total value of stock - 100 lakhs.
Provisions required based on 12 months issue 3.5 Iakhs
Provisions required based on technical evaluation ‘ 2.5 lakhs.
Does this amount to change in accounting policy ? Can the company change the method of
provision?

ANSWER:

(i) Provision of AS
The decision of making provisions for non-moving stocks on the basis of technical
evaluation does not amount to change in accounting policy. Accounting policy of a
company may require that provision for non-moving stocks should be made. The method
of estimating the amount of provision may be changed in case a more prudent estimate
can !ie made.
(ii) Analysis and Conclusion
In the given case, considering the total value of stock, the change in the amount of
required provision of non-moving stock from ‘ 3.5 lakhs to 2.5 Iakhs is also not material.
The disclosure can be made for such change in the following lines by way of notes to
the accounts in the annual accounts of ABC Ltd. for the year 2011-12.
“The company has provided for non-moving stocks on the basis of technical evaluation
unlike preceding years. Had the same method been followed as in the previous year,
the profit for the year and the corresponding effect on the year end net assets would
have been higher by Rs 1 Lakh.

  QUESTION NO 46
“ In determining the cost of inventories, it is appropriate to exclude certain costs and
recognize them as expenses in the period in which they are incurred. “ Provide example of
such costs as per IND AS-2: Valuation of Inventories.

ANSWER:
As per of IND AS 2, “Valuation of Inventories” in determining the cost of inventories, it
is appropriate to exclude following costs and recognize them as expenses in the period in
which they are incurred:

(a) Abnormal amounts of wasted materials, labour, or other production cost:

 IND AS-2: VALUATION OF INVENTORIES 41

(b) Storage cost, unless the production process requires such storage,
(c) Administrative overheads that do not contribute to bringing the inventories to their
present location and condition.
(d) Selling and distribution cost.

STUDY MATERIAL PRACTICAL QUESTIONS

  QUESTION NO 1
UA Ltd. purchased raw material @ ` 400 per kg. Company does not sell raw material but
uses in production of finished goods. The finished goods in which raw material is used are
expected to be sold at below cost. At the end of the accounting year, company is having
10,000 kg of raw material in inventory. As the company never sells the raw material, it
does not know the selling price of raw material and hence cannot calculate the realizable
value of the raw material for valuation of inventories at the end of the year. However,
replacement cost of raw material is ` 300 per kg. How will you value the inventory of raw
material?

ANSWER:
As per Ind AS 2 “Inventories”, materials and other supplies held for use in the production
of inventories are not written down below cost if the finished products in which they will
be incorporated are expected to be sold at or above cost. However, when there has been a
decline in the price of materials and it is estimated that the cost of the finished products will
exceed net realizable value, the materials are written down to net realizable value. In such
circumstances, the replacement cost of the materials may be the best available measure of
their net realizable value. Therefore, in this case, UA Ltd. will value the inventory of raw
material at ` 30,00,000 (10,000 kg. @ ` 300 per kg.).

  QUESTION NO 2
Sun Ltd. has fabricated special equipment (solar power panel) during 20X1-20X2 as per
drawing and design supplied by the customer. However, due to a liquidity crunch, the
customer has requested the company for postponement in delivery schedule and requested
the company to withhold the delivery of finished goods products and discontinue the
production of balance items.
As a result of the above, the details of customer balance and the goods held by the
company as work-in-progress and finished goods as on 31-03-20X3 are as follows:
Solar power panel (WIP) ` 85 lakhs
Solar power panel (finished products) ` 55 lakhs
 42 IND AS-2: VALUATION OF INVENTORIES

Sundry Debtor (solar power panel) ` 65 lakhs

The petition for winding up against the customer has been filed during 20X2-20X3 by Sun
Ltd. Comment with explanation on provision to be made of ` 205 lakh included in Sundry
Debtors, Finished goods and work-in-progress in the financial statement of 20X2-20X3.

ANSWER:
From the fact given in the question it is obvious that Sun Ltd. is a manufacturer of solar
power panel. As per Ind AS 2 ‘Inventories’, inventories are assets (a) held for sale in the
ordinary course of business; (b) in the process of production for such sale; or (c) in the form
of materials or supplies to be consumed in the production process or in the rendering of
services. Therefore, solar power panel held in its stock will be considered as its inventory.
Further, as per the standard, inventory at the end of the year are to be valued at lower of
cost or NRV.
As the customer has postponed the delivery schedule due to liquidity crunch the entire cost
incurred for solar power panel which were to be supplied has been shown in Inventory. The
solar power panel are in the possession of the Company which can be sold in the market.
Hence company should value such inventory as per principle laid down in Ind AS 2 i.e. lower of
Cost or NRV. Though, the goods were produced as per specifications of buyer the Company
should determine the NRV of these goods in the market and value the goods accordingly.
Change in value of such solar power panel should be provided for in the books. In the
absence of the NRV of WIP and Finished product given in the question, assuming that cost
is lower, the company shall value its inventory as per Ind AS 2 for ` 140 lakhs [i.e solar
power panel (WIP) ` 85 lakhs + solar power panel (finished products) ` 55 lakhs].
Alternatively, if it is assumed that there is no buyer for such fabricated solar power panel,
then the NRV will be Nil. In such a case, full value of finished goods and WIP will be
provided for in the books.
As regards Sundry Debtors balance, since the Company has filed a petition for winding up
against the customer in 20X2-20X3, it is probable that amount is not recoverable from the
party. Hence, the provision for doubtful debts for ` 65 lakhs shall be made in the books
against the debtor’s amount.
 IND AS-2: VALUATION OF INVENTORIES 43

PAST EXAMS QUESTIONS

QUESTION 1 MAY 2018 EXAM
XYZ Limited has a plant with the normal capacity to produce 10,00,000 units of a product
per annum and the expected fixed overhead is ` 30,00,000, Fixed overhead, therefore
based on normal capacity is ` 3 per unit.
Determine Fixed overhead as per Ind AS 2’ Inventories’ if

(i) Actual production is 15,00,000 units.

(ii) Actual production is 7,50,000 units

ANSWER
(i) Actual production is 7,50,000 units: Fixed overhead is not going to change with the
change in output and will remain constant at ` 30,00,000, therefore, overheads on
actual basis is ` 4 per unit (30,00,000/7,50,000).

Hence, by vvaluing inventory ` 4 each for fixed overhead purpose, it will be overvalued
and the losses of ` 7,50,000 will also be included in closing inventory leading to a high-
er gross profit then actually earned.

Therefore, it is advisable to include fixed overhead per unit on normal capacity to

actual production (7,50,000 x 3) ` 22,50,000 and balance ` 7,50,000 shall be trans-
ferred to Profit & Loss Account.

(ii) Actual production is 15,00,000 units : Fixed overhead is not going to change with
the change in output and will remain constant at ` 30,00,000, therefore, overheads on
actual basis is ` 2 (30,00,000/15,00,000).

Hence by valuing inventory at ` 3 each for fixed overhead purpose, we will be adding
the element of cost to inventory which actually has not been incurred. At ` 3 per unit,
total fixed overhead comes to ` 45,00,000 whereas, actual fixed overhead expense is
only ` 30,00,000. Therefore, it is advisable to include fixed overhead on actual basis
(15,00,000 x2) ` 30,00,000.
44 IND AS-2: VALUATION OF INVENTORIES

NOTES
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 45

IND AS 16: PROPERTY, PLANT & EQUIPMENT

CONCEPT 1: OBJECTIVE
The objective of this Standard is to prescribe the accounting treatment for property,
plant and equipment. The principal issues in accounting for property, plant and equipment
are the recognition of the assets, the determination of their carrying amounts and the
depreciation charges and impairment losses to be recognised in relation to them.
Under Ind AS 16, property, plant and equipment is initially measured at its cost, subsequently
measured using either a cost or a revaluation model and depreciated so that its depreciable
amount is allocated on a systematic basis over its useful life.

CONCEPT 2: SCOPE

• This Standard shall be applied in accounting for property, plant and equipment except
when another Standard requires or permits a different accounting treatment.
• This Standard does not apply to:

(a) PPE classified as held for (b) Biological assets related to

sale (as per Ind AS 105) agricultural activity other than
bearer plants (Ind AS 41)

(c) Recognition and (d) Mineral rights and mineral

measurement of exploration reserves such as oil, natural gas and
and evaluation assets (Ind similar non -regenerative resources
AS 106)

• However, this Standard applies to property, plant and equipment used to develop or
maintain the assets described in (b)–(d).
• It may be noted that other Indian Accounting Standards may require recognition of an
item of property, plant and equipment based on an approach different from that in this
Standard. For example, Ind AS 17, Leases, requires an entity to evaluate its recognition
of an item of leased property, plant and equipment on the basis of the transfer of risks
and rewards. However, in such cases other aspects of the accounting treatment for
these assets, including depreciation, are prescribed by this Standard.
• An entity accounting for investment property in accordance with Ind AS 40, Investment
Property shall use the cost model in this Standard.
 46 IND AS 16: PROPERTY, PLANT & EQUIPMENT

CONCEPT 3: RELEVANT DEFINITIONS

The following are the key terms used in this standard:

• Property, plant and equipment are tangible items that:

a) are held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes; and
b) are expected to be used during more than one period.

Held for use in production or supply /

Rental / Administrative purposes

Expected to used
Tangible items during more than one
period

PPE

• A bearer plant is a living plant that:

(a) is used in the production or supply of agricultural produce;
(b) is expected to bear produce for more than one period; and
(c) has a remote likelihood of being sold as agricultural produce, except for incidental
scrap sales.
• Carrying amount is the amount at which an asset is recognised after deducting any
accumulated depreciation and accumulated impairment losses.
• Cost is the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or construction
or, where applicable, the amount attributed to that asset when initially recognised in
accordance with the specific requirements of other Indian Accounting Standards, e.g.
Ind AS 102, Share-based Payment.
• Depreciable amount is the cost of an asset, or other amount substituted for cost, less
its residual value.
• Depreciation is the systematic allocation of the depreciable amount of an asset over its
useful life.
• Entity-specific value is the present value of the cash flows an entity expects to arise
from the continuing use of an asset and from its disposal at the end of its useful life or
expects to incur when settling a liability.
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 47

• Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date. (See Ind AS 113, Fair Value Measurement.)
• An impairment loss is the amount by which the carrying amount of an asset exceeds its
recoverable amount.
• Recoverable amount is the higher of an asset’s fair value less costs to sell and its value
in use.
• The residual value of an asset is the estimated amount that an entity would currently
obtain from disposal of the asset, after deducting the estimated costs of disposal, if
the asset were already of the age and in the condition expected at the end of its useful
life.
• Useful life is:
a) the period over which an asset is expected to be available for use by an entity; or
b) the number of production or similar units expected to be obtained from the asset
by an entity.

CONCEPT 4: RECOGNITION
General recognition criteria
The cost of an item of property, plant and equipment shall be recognised as an asset if, and
only if:
a) it is probable that future economic benefits associated with the item will flow to the
entity; and
b) the cost of the item can be measured reliably.

Probable that
future economic
benefit will
flow to entity
Recognition of
cost as an
asset (PPE)

Cost can be
measured reliably
 48 IND AS 16: PROPERTY, PLANT & EQUIPMENT

CONCEPT 5: SPARE PARTS, STAND-BY

EQUIPMENT AND SERVICING EQUIPMENT
Items such as spare parts, stand-by equipment and servicing equipment are recognised in
accordance with this Ind AS when they meet the definition of property plant and equipment
otherwise, such items are classified as inventory.

CONCEPT 6: AGGREGATION OF
INDIVIDUALLY INSIGNIFICANT ITEMS
This Standard does not prescribe the unit of measure for recognition, ie what constitutes
an item of property, plant and equipment. Thus, judgement is required in applying the
recognition criteria to an entity’s specific circumstances. It may be appropriate to aggregate
individually insignificant items, such as moulds, tools and dies, and to apply the criteria to
the aggregate value.

CONCEPT 7: INITIAL COST

Items of property, plant and equipment may be acquired for safety or environmental reasons.
The acquisition of such property, plant and equipment, although not directly increasing the
future economic benefits of any particular existing item of property, plant and equipment,
may be necessary for an entity to obtain the future economic benefits from its other
assets.
Such items of property, plant and equipment qualify for recognition as assets because they
enable an entity to derive future economic benefits from related assets in excess of what
could be derived had those items not been acquired.
For example: A chemical manufacturer may install new chemical handling processes to comply
with environmental requirements for the production and storage of dangerous chemicals;
related plant enhancements are recognised as an asset because without them the entity
is unable to manufacture and sell chemicals. However, the resulting carrying amount of
such an asset and related assets is reviewed for impairment in accordance with Ind AS 36
Impairment of Assets.
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 49

CONCEPT 8: SUBSEQUENT COSTS

Repair & Maintenance

(Day to Day Servicing)

Replacement at Major Inspection/

Regular Intervals Overhauls

CONCEPT 9: REPAIR AND MAINTENANCE

An entity does not recognise in the carrying amount of an item of property, plant and
equipment the costs of the day-to-day servicing of the item. Rather, these costs are
recognised in profit or loss as incurred. Costs of day-to -day servicing are primarily the
costs of labour and consumables, and may include the cost of small parts.

CONCEPT 10: REPLACEMENT PARTS

Parts of some items of property, plant and equipment may require replacement at regular
intervals. For example, a furnace may require relining after a specified number of hours of
use, or aircraft interiors such as seats and galleys may require replacement several times
during the life of the airframe.
Items of property, plant and equipment may also be acquired to make a less frequently
recurring replacement, such as replacing the interior walls of a building, or to make a non-
recurring replacement.
Under the recognition principle, an entity recognises in the carrying amount of an item of
property, plant and equipment the cost of replacing part of such an item when that cost is
incurred if the recognition criteria are met. The carrying amount of those parts that are
replaced is derecognised in accordance with the derecognition provisions of this Standard.

CONCEPT 10: MAJOR INSPECTIONS OR OVERHAULS

A condition of continuing to operate an item of property, plant and equipment may be
performing regular major inspections for faults regardless of whether parts of the item
are replaced.
When each major inspection is performed, its cost is recognised in the carrying amount of
the item of property, plant and equipment as a replacement if the recognition criteria are
satisfied.
 50 IND AS 16: PROPERTY, PLANT & EQUIPMENT

Any remaining carrying amount of the cost of the previous inspection is derecognised. This
occurs regardless of whether the cost of the previous inspection was identified in the
transaction in which the item was acquired or constructed. If necessary, the estimated
cost of a future similar inspection may be used as an indication of what the cost of the
existing inspection component was when the item was acquired or constructed.

CONCEPT 11: MEASUREMENT AT RECOGNITION

Measurement at cost
An item of property, plant and equipment that qualifies for recognition as an asset should
be initially measured at its cost.

Element of cost

CASE I: COST OF AN ACQUIRED ASSET

Component of cost
The cost of an item of property, plant and equipment comprises:

a) its purchase price, including import duties and non-refundable purchase taxes, after
deducting trade discounts and rebates;
b) any costs directly attributable to bringing the asset to the location and condition
necessary for it to be capable of operating in the manner intended by management;
and
c) the initial estimate of the costs of dismantling and removing the item and restoring
the site on which it is located, the obligation for which an entity incurs either when
the item is acquired or as a consequence of having used the item during a particular
period for purposes other than to produce inventories during that period.

Initially measured at cost

Purchase price including Initial estimate of the

import duties and non- Directly attributable costs of dismantling
refundable purchase Cost and removing the item
taxes and restoring
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 51

CASE II: COST OF SELF-CONSTRUCTED ASSET

The cost of a self -constructed asset is determined using the same principles as for an
acquired asset. If an entity makes similar assets for sale in the normal course of business,
the cost of the asset is usually the same as the cost of constructing an asset for sale.

Examples of directly attributable costs are:

Employee benefits cost arising directly from construction or acquisition PPE

Cost of Site Preparation

Initial delivery and handling costs

Installation and assembly costs

Professional Fees

Costs of testing- whether the asset is working properly after deducting proceeds from
sale of any product produced during the testing period.

• Example of costs that are not costs of an item of property, plant and equipment
are:

Costs of
conducting
business in a Costs incurred Administrative
new location or in introducing a Cost of opening a and other
with a new class new product or new facility general overhead
of customer service costs
(including costs
of staff
training)

Therefore, any internal profits are eliminated in arriving at such costs. Similarly, the
cost of abnormal amounts of wasted material, labour, or other resources incurred in self-
constructing an asset is not included in the cost of the asset.
Ind AS 23, Borrowing Costs, establishes criteria for the recognition of interest as
a component of the carrying amount of a self-constructed item of property, plant and
equipment.
 52 IND AS 16: PROPERTY, PLANT & EQUIPMENT

Bearer plants are accounted for in the same way as self-constructed items of property,
plant and equipment before they are in the location and condition necessary to be capable of
operating in the manner intended by management. Consequently, references to ‘construction’
in this Standard should be read as covering activities that are necessary to cultivate the
bearer plants before they are in the location and condition necessary to be capable of
operating in the manner intended by management.

Cost of dismantling, removal and site restoration

Cost incurred by an entity in respect of obligation for dismantling, removing and restoring
the site on which an item of property, plant and equipment is located are recognised and
measured in accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent
Assets.
If the obligations are incurred when the asset is acquired, or during a period when the
item is used other than to produce inventories, they are included in the cost of the item
property, plant and equipment.
An entity applies Ind AS 2, Inventories, to the costs of obligations for dismantling, removing
and restoring the site on which an item is located that are incurred during a particular
period as a consequence of having used the item to produce inventories during that period.

Incidental operations
Some operations occur in connection with the construction or development of an item of
property, plant and equipment, but are not necessary to bring the item to the location and
condition necessary for it to be capable of operating in the manner intended by management.
These incidental operations may occur before or during the construction or development
activities. For example, income may be earned through using a building site as a car park
until construction starts.
Because incidental operations are not necessary to bring an item to the location and condition
necessary for it to be capable of operating in the manner intended by management, the
income and related expenses of incidental operations are recognised in profit or loss and
included in their respective classifications of income and expense.

Cessation of capitalisation
Recognition of costs in the carrying amount of an item of property, plant and equipment
ceases when the item is in the location and condition necessary for it to be capable of
operating in the manner intended by management. Therefore, costs incurred in using or
redeploying an item are not included in the carrying amount of that item.
For example, the following costs are not included in the carrying amount of an item of
property, plant and equipment:
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 53

a) costs incurred while an item capable of operating in the manner intended by management
has yet to be brought into use or is operated at less than full capacity;
b) initial operating losses, such as those incurred while demand for the item’s output
builds up; and
c) costs of relocating or reorganising part or all of an entity’s operations.

  EXAMPLE

Moon Ltd incurs the following costs in relation to the construction of a new factory and
the introduction of its products to the local market.

Particulars INR,000 INR,000

(cost (As per Ind
incurred) AS16)
Site preparation costs 150 150
Direct Material 2,000 2,000
Direct Labour cost, including `10,000 incurred during an 1,160 1,150
industrial strike
Testing of various processes in factory 200 200
Consultancy fees for installation of equipment 300 300
Relocation of staff to new factory 450 -
General overheads 550 -
Estimated Costs to dismantle (at present value) 200 200
Total Cost to be Capitalised as per Ind AS 16 4,000

CASE III: PAYMENT DEFERRED BEYOND NORMAL CREDIT TERMS

The cost of an item of property, plant and equipment is the cash price equivalent at the
recognition date. If payment is deferred beyond normal credit terms, the difference
between the cash price equivalent and the total payment is recognised as interest over the
period of credit unless such interest is capitalised in accordance with Ind AS 23.

CASE IV: EXCHANGE OF ASSETS

• One or more items of property, plant and equipment may be acquired in exchange for a
non-monetary asset or assets, or a combination of monetary and nonmonetary assets.
The cost of such an item of property, plant and equipment is measured at fair value
(even if an entity cannot immediately derecognise the asset given up) unless:
 54 IND AS 16: PROPERTY, PLANT & EQUIPMENT

a) the exchange transaction lacks commercial substance; or

b) the fair value of neither the asset received nor the asset given up is reliably
measurable.
• If the acquired item is not measured at fair value, its cost is measured at the carrying
amount of the asset given up.
• An entity determines whether an exchange transaction has commercial substance by
considering the extent to which its future cash flows are expected to change as a result
of the transaction. An exchange transaction has commercial substance if:
a) the configuration (risk, timing and amount) of the cash flows of the asset received
differs from the configuration of the cash flows of the asset transferred; or
b) the entity-specific value of the portion of the entity’s operations affected by
the transaction changes as a result of the exchange; and
c) the difference in (a) or (b) is significant relative to the fair value of the assets
exchanged.
• For the purpose of determining whether an exchange transaction has commercial
substance, the entity-specific value of the portion of the entity’s operations affected
by the transaction shall reflect post-tax cash flows.
• he fair value of an asset is reliably measurable if:
a) the variability in the range of reasonable fair value measurements is not significant
for that asset or
b) the probabilities of the various estimates within the range can be reasonably
assessed and used when measuring fair value.
• If an entity is able to measure reliably the fair value of either the asset received or
the asset given up, then the fair value of the asset given up is used to measure the
cost of the asset received unless the fair value of the asset received is more clearly
evident.

If PPE is acquired in exchange for other non-monetary asset or for a

combination of monetary and non-monetary asset

Measure cost at fair value

Unless the exchange transaction Fair value of neither the asset
has no commercial substance or received for given up can be
measured reliably
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 55

CASE V: ASSETS HELD UNDER FINANCE LEASE

The cost of an item of property, plant and equipment held by a lessee under a finance lease
is determined in accordance with Ind AS 17, Leases.

CONCEPT 12: MEASUREMENT AFTER RECOGNITION

Alternative bases available for measurement after recognition

A entity may choose either the cost model or the revaluation model as its accounting policy
and should apply that policy to an entire class of property, plant and equipment.

Cost model
After recognition as an asset, an item of property, plant and equipment should be carried
at its cost less any accumulated depreciation and any accumulated impairment losses.

Cost

Accumulated
Carrying Amount
Depreciation

Accumulated
Impairment Loss

Revaluation model
After recognition as an asset, an item of property, plant and equipment whose fair value
can be measured reliably is carried at a revalued amount, being its fair value at the date of
the revaluation less any subsequent accumulated depreciation and subsequent accumulated
impairment losses. Revaluations are required to be carried out with sufficient regularity
to ensure that the carrying amount does not differ materially from that which would be
determined using fair value at the end of the reporting period.
 56 IND AS 16: PROPERTY, PLANT & EQUIPMENT

FV at the date of
revaluation

Subsequent
Accumulated Carrying Amount
Depreciation

Subsequent
Accumulated
Impairment Loss

Frequency of revaluations

• The frequency of revaluations depends upon the changes in fair values of the items of
property, plant and equipment being revalued. When the fair value of a revalued asset
differs materially from its carrying amount, a further revaluation is required. Some
items of property, plant and equipment experience significant and volatile changes in
fair value, thus necessitating annual revaluation.
• Such frequent revaluations are unnecessary for items of property, plant and equipment
with only insignificant changes in fair value. Instead, it may be necessary to revalue the
item only every three or five years.

Accumulated depreciation at the date of revaluation

• When an item of property, plant and equipment is revalued, the carrying amount of
that asset is adjusted to the revalued amount. At the date of revaluation, the asset is
treated in one of the following ways:
a) The gross carrying amount is adjusted in a manner that is consistent with the
revaluation of the carrying amount of the asset. For example, the gross carrying
amount may be restated by reference to observable market data or it may be
restated proportionately to the change in the carrying amount. The accumulated
depreciation at the date of the revaluation is adjusted to equal the difference
between the gross carrying amount and the carrying amount of the asset after
taking into account accumulated impairment losses; or
b) The accumulated depreciation is eliminated against the gross carrying amount of
the asset.
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 57

Revaluation to be made for entire class of assets

If an item of property, plant and equipment is revalued, the entire class of property, plant
and equipment to which that asset belongs shall be revalued.
A class of property, plant and equipment is a grouping of assets of a similar nature and use
in an entity’s operations. The following are examples of separate classes:

Land

Land and Buildings

Machinery

Ships

Aircraft

Motor Vehicles

Furniture and Fixtures

Office Equipment

Bearer Plants

The items within a class of property, plant and equipment are revalued simultaneously to
avoid selective revaluation of assets and the reporting of amounts in the financial statements
that are a mixture costs and values as at different dates.
However, a class of assets may be revalued on a rolling basis provided revaluation of the
class of assets is completed within a short period and provided the revaluations are kept
up to date.

Treatment of Surplus or Deficit arising on Revaluation

• If an asset’s carrying amount is increased as a result of a revaluation, the increase

should be recognised in other comprehensive income and accumulated in equity under the
heading of revaluation surplus. However, the increase should be recognised in profit or
loss to the extent that it reverses a revaluation decrease of the same asset previously
recognised in profit or loss.
• If an asset’s carrying amount is decreased as a result of a revaluation, the decrease should
be recognised in profit or loss. However, the decrease should be recognised in other
comprehensive income to the extent of any credit balance existing in the revaluation
surplus in respect of that asset. The decrease recognised in other comprehensive income
reduces the amount accumulated in equity under the heading of revaluation surplus.
 58 IND AS 16: PROPERTY, PLANT & EQUIPMENT

Treatment of revaluation gain and loss is summarized in the below diagram:

First Time

Increase Decrease

Recognised in OCI as Profit or Loss

Revaluation Surplus
Subsequent

Increase Decrease
Increase Decrease

Debited to Charge to P&L

Recognised in OCI Revaluation Surplus to the extent of
as Revaluation to the extent earlier debit to Charge to P&L
Surplus available and P&L and balance to
balance to P&L revaluation surplus

The revaluation surplus included in equity in respect of an item of property, plant and
equipment may be transferred directly to retained earnings when the asset is derecognised.
This may involve transferring the whole of the surplus when the asset is retired or disposed
of.
However, some of the surplus may be transferred as the asset is used by an entity. In such a
case, the amount of the surplus transferred would be the difference between depreciation
based on the revalued carrying amount of the asset and depreciation based on the asset’s
original cost. Transfers from revaluation surplus to retained earnings are not made through
profit or loss.
The effects of taxes on income, if any, resulting from the revaluation of property, plant
and equipment are recognised and disclosed in accordance with Ind AS 12, Income Taxes.

CONCEPT 13: DEPRECIATION

• The depreciable amount of an asset should be allocated on a systematic basis over its
useful life. The depreciation charge for each period should be recognised in profit or
loss unless it is included in the carrying amount of another asset.
• Each part of an item of property, plant and equipment with a cost that is significant in
relation to the total cost of the item should be depreciated separately.
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 59

• An entity allocates the amount initially recognised in respect of an item of property,

plant and equipment to its significant parts and depreciates separately each such part.
• A significant part of an item of property, plant and equipment may have a useful life and
a depreciation method that are the same as the useful life and the depreciation method
of another significant part of that same item. Such parts may be grouped in determining
the depreciation charge.
• To the extent that an entity depreciates separately some parts of an item of property,
plant and equipment, it also depreciates separately the remainder of the item. The
remainder consists of the parts of the item that are individually not significant. If
an entity has varying expectations for these parts, approximation techniques may be
necessary to depreciate the remainder in a manner that faithfully represents the
consumption pattern and/or useful life of its parts.
• Land and buildings are separable assets and are accounted for separately, even when
they are acquired together. With some exceptions, such as quarries and sites used for
landfill, land has an unlimited useful life and therefore is not depreciated. Buildings have
a limited useful life and therefore are depreciable assets. An increase in the value of
the land on which a building stands does not affect the determination of the depreciable
amount of the building.
• If the cost of land includes the costs of site dismantlement, removal and restoration,
that portion of the land asset is depreciated over the period of benefits obtained by
incurring those costs. In some cases, the land itself may have a limited useful life, in
which case it is depreciated in a manner that reflects the benefits to be derived from
it.

Residual Value
The residual value and the useful life of an asset should be reviewed at least at each
financial year-end and, if expectations differ from previous estimates, the change(s)
should be accounted for as a change in an accounting estimate in accordance with Ind AS 8,
Accounting Policies, Changes in Accounting Estimates and Errors.

  EXAMPLE : REVISION OF USEFUL LIFE

An asset which cost ` 10,000 was estimated to have a useful life of 10 years and residual
value ` 2000. After two years, useful life was revised to 4 remaining years.
Calculate the depreciation charge.
 60 IND AS 16: PROPERTY, PLANT & EQUIPMENT

SOLUTION:
INR

Year-1 Year-2 Year-3

Cost 10,000 10,000 10,000
Less: Accumulated Depreciation (800) (1,600) (3,200)
Carrying Amount 9,200 8,400 6,800
10,000 - 2,000 10,000 - 2,000 8,400 - 2,000
Charges for year 10 10 10
= 800 = 800 = 1,600

• The residual value of an asset may increase to an amount equal to or greater than the
asset’s carrying amount. If it does, the asset’s depreciation charge is zero unless and
until its residual value subsequently decreases to an amount below the asset’s carrying
amount.
• Depreciation is recognised even if the fair value of the asset exceeds its carrying
amount, as long as the asset’s residual value does not exceed its carrying amount. Repair
and maintenance of an asset do not negate the need to depreciate it.

Commencement of depreciation
Depreciation of an asset begins when it is available for use, i.e. when it is in the location and
condition necessary for it to be capable of operating in the manner intended by management.

Cessation of depreciation

• Depreciation of an asset ceases at the earlier of:

a) the date that the asset is classified as held for sale (or included in a disposal
group that is classified as held for sale) in accordance with Ind AS 105.
b) and the date that the asset is derecognised.
• Therefore, depreciation does not cease when the asset becomes idle or is retired from
active use unless the asset is fully depreciated. However, under usage methods of
depreciation the depreciation charge can be zero while there is no production.

Factors affecting the useful life of an asset

The future economic benefits embodied in an asset are consumed by an entity principally
through its use. However, other factors, such as technical or commercial obsolescence and
wear and tear while an asset remains idle, often result in the diminution of the economic
benefits that might have been obtained from the asset. Consequently, all the following
factors are considered in determining the useful life of an asset:
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 61

a) expected usage of the asset. Usage is assessed by reference to the asset’s expected
capacity or physical output;
b) expected physical wear and tear, which depends on operational factors such as the
number of shifts for which the asset is to be used and the repair and maintenance
programme, and the care and maintenance of the asset while idle;
c) technical or commercial obsolescence arising from changes or improvements in
production, or from a change in the market demand for the product or service output
of the asset. Expected future reductions in the selling price of an item that was
produced using an asset could indicate the expectation of technical or commercial
obsolescence of the asset, which, in turn, might reflect a reduction of the future
economic benefits embodied in the asset; and
d) legal or similar limits on the use of the asset, such as the expiry dates of related
leases.

Impact of an entity’s asset management policy

The useful life of an asset is defined in terms of the asset’s expected utility to the
entity. The asset management policy of the entity may involve the disposal of assets after
a specified time or after consumption of a specified proportion of the future economic
benefits embodied in the asset.
Therefore, the useful life of an asset may be shorter than its economic life. The estimation
of the useful life of the asset is a matter of judgement based on the experience of the
entity with similar assets.

Depreciation method
The depreciation method used shall reflect the pattern in which the asset’s future economic
benefits are expected to be consumed by the entity.
The depreciation method applied to an asset is reviewed at least at each financial year-end
and, if there has been a significant change in the expected pattern of consumption of the
future economic benefits embodied in the asset, the method should be changed to reflect
the changed pattern. Such a change is accounted for as a change in an accounting estimate
in accordance with Ind AS8.

  EXAMPLE: CHANGE IN DEPRECIATION METHOD

An entity acquired an asset 3 years ago at a cost of ` 5 million. The depreciation method
adopted for the asset was 10 percent reducing balance method.
At the end of Year 3, the entity estimates that the remaining useful life of the asset is 8
years and determines to adopt straight –line method from that date so as to reflect the
revised estimated pattern of recovery of economic benefits.
 62 IND AS 16: PROPERTY, PLANT & EQUIPMENT

Show the necessary treatment in accordance of Ind AS 16.

SOLUTION:
Change in Depreciation Method shall be accounted for as a change in an accounting estimate
in accordance of Ind AS 8 and hence will have a prospective effect.
Depreciation Charges for year 1 to 11 will be as follows:

Year 1 ` 500,000
Year 2 ` 450,000
Year 3 ` 405,000
Year 4 to year 11 ` 456,000 p.a.

A variety of depreciation methods can be used to allocate the depreciable amount of an

asset on a systematic basis over its useful life. These methods include:

a) Straight-line depreciation method results in a constant charge over the useful life if
the asset’s residual value does not change.
b) Diminishing balance method results in a decreasing charge over the useful life.
c) Units of production method results in a charge based on the expected use or output.
The entity selects the method that most closely reflects the expected pattern of
consumption of the future economic benefits embodied in the asset. That method is applied
consistently from period to period unless there is a change in the expected pattern of
consumption of those future economic benefits.
A depreciation method that is based on revenue that is generated by an activity that includes
the use of an asset is not appropriate. The revenue generated by an activity that includes
the use of an asset generally reflects factors other than the consumption of the economic
benefits of the asset (e.g. other inputs and processes, selling activities and changes in sales
volumes and prices).

Depreciation

Asset unused or held

Fair value >Carrying
for sale or included in
Amount (Residual value Residual Value > =
a disposal group that is
is less than Carrying Carrying Amount
classified as held for
Amount
sale

Depreciation Charged Depreciation Zero Depreciation Ceases

 IND AS 16: PROPERTY, PLANT & EQUIPMENT 63

IMPAIRMENT

Identification of an impairment loss

To determine whether an item of property, plant and equipment is impaired, an entity applies
Ind AS 36, Impairment of Assets. Ind AS 36 explains how an entity reviews the carrying
amount of its assets, how it determines the recoverable amount of an asset, and when it
recognises, or reverses the recognition of, an impairment loss.

Compensation for impairment

• Compensation from third parties for items of property, plant and equipment that were
impaired, lost or given up shall be included in profit or loss when the compensation
becomes receivable.
• Impairments or losses of items of property, plant and equipment, related claims for
or payments of compensation from third parties and any subsequent purchase or
construction of replacement assets are separate economic events and are accounted
for separately as follows:
a) impairments of items of property, plant and equipment are recognised in accordance
with Ind AS 36;
b) derecognition of items of property, plant and equipment retired or disposed of is
determined in accordance with this Standard;
c) compensation from third parties for items of property, plant and equipment that
were impaired, lost or given up is included in determining profit or loss when it
becomes receivable; and
d) the cost of items of property, plant and equipment restored, purchased or
constructed as replacements is determined in accordance with this Standard.

CONCEPT 14: DERECOGNITION

Derecognition - general

• The carrying amount of an item of property, plant and equipment should be derecognised:
a) on disposal; or
b) when no future economic benefits are expected from its use or disposal.
• The gain or loss arising from the derecognition of an item of property, plant and
equipment is included in profit or loss when the item is derecognised (unless Ind AS 17
requires otherwise on a sale and leaseback). Gains shall not be classified as revenue.
• The gain or loss arising from the derecognition of an item of property, plant and
equipment shall be determined as the difference between the net disposal proceeds, if
any, and the carrying amount of the item.
 64 IND AS 16: PROPERTY, PLANT & EQUIPMENT

• In determining the date of disposal of an item, an entity applies the criteria in Ind AS
18 for recognising revenue from the sale of goods. Ind AS 17 applies to disposal by a sale
and leaseback.
• The amount of consideration to be included in the gain or loss arising from the
derecognition of an item of property, plant and equipment is determined in accordance
with the requirements for determining the transaction price in Ind AS 18.
• Subsequent changes to the estimated amount of the consideration included in the gain
or loss shall be accounted for in accordance with the requirements for changes in the
transaction price in Ind AS 18.

CONCEPT 15: DISCLOSURE

Disclosure-general

• The financial statements should disclose, for each class of property, plant and
equipment:
a) the measurement bases used for determining the gross carrying amount;
b) the depreciation methods used;
c) the useful lives or the depreciation rates used; and
d) the gross carrying amount and the accumulated depreciation (aggregated with
accumulated impairment losses) at the beginning and end of the period.
• Entity is also required to provide a reconciliation of the carrying amount at the
beginning and end of the period showing:
a) additions;
b) assets classified as held for sale or included in a disposal group classified as held
for sale in accordance with Ind AS 105 and other disposals;
c) acquisitions through business combinations;
d) increases or decreases resulting from revaluations and from impairment losses
recognised or reversed in other comprehensive income;
e) impairment losses recognised in profit or loss in accordance with Ind AS 36;
f) impairment losses reversed in profit or loss in accordance with Ind AS 36;
g) depreciation;
h) the net exchange differences arising on the translation of the financial statements
from the functional currency into a different presentation currency, including the
translation of a foreign operation into the presentation currency of the reporting
entity; and
i) other changes.
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 65

• The financial statements are also disclose:

a) the existence and amounts of restrictions on title, and property, plant and
equipment pledged as security for liabilities;
b) the amount of expenditures recognised in the carrying amount of an item of
property, plant and equipment in the course of its construction;
c) the amount of contractual commitments for the acquisition of property, plant and
equipment; and
d) if it is not disclosed separately in the statement of profit and loss, the amount of
compensation from third parties for items of property, plant and equipment that
were impaired, lost or given up that is included in profit or loss.

Items stated at revalued amounts

• If items of property, plant and equipment are stated at revalued amounts, the
following should be disclose:
a) the effective date of the revaluation;
b) whether an independent valuer was involved;
c) for each revalued class of property, plant and equipment, the carrying amount
that would have been recognised had the assets been carried under the cost
model; and
d) the revaluation surplus, indicating the change for the period and any restrictions
on the distribution of the balance to shareholders.

Additional recommended disclosure

• Entities are encourages but does not required, to disclose the following amounts:
a) the carrying amount of temporarily idle property, plant and equipment;
b) the gross carrying amount of any fully depreciated property, plant and equipment
that is still in use;
c) the carrying amount of property, plant and equipment retired from active use and
not classified as held for sale in accordance with Ind AS 105; and
d) when the cost model is used, the fair value of property, plant and equipment when
this is materially different from the carrying amount.
 66 IND AS 16: PROPERTY, PLANT & EQUIPMENT

SIGNIFICANT DIFFERENCES IN IND AS 16 VIS-À-VIS AS 10

S.No. Particular Ind AS 16 AS 10

1. Fixed Assets retired Ind AS 16 does not deal AS 10 deals with
from Active Use and with the assets ‘held for accounting for items
Held for Sale sale’ because the treatment of fixed assets retired
of such assets is covered in from active use and
Ind AS 105, Non- current held for sale.
Assets Held for Sale and
Discontinued Operations.
2. Stripping Costs in the Ind AS 16 provides guidance AS 10 does not contain
Production Phase of a on measuring ‘Stripping Costs this guidance.
Surface Mine in the Production Phase of a
Surface Mine’.

PRACTICAL QUESTIONS FOR PRACTICE

ON VARIOUS CONCEPTS

  QUESTION 1 (REPLACEMENT)
MS Ltd. has acquired a heavy machinery at a cost of ` 1,00,00,000 (with no breakdown of
the component parts) . The estimated useful life is 10 years. At the end of the sixth year,
one of the major components, the turbine requires replacement, as further maintenance is
uneconomical. The remainder of the machine is perfect and is expected to last for the next
four years. The cost of a new turbine is ` 45,00,000.
Can the cost of the new turbine be recognised as an asset, and, if so, what treatment should
be used?

  QUESTION 2 (ACQUISITION OF ASSETS)

On April 1, 20X1, XYZ Ltd, acquired a machine under the following terms:

`
List price of machine 80,00,000
Import duty 5,00,000
Delivery fees 1,00,000
Electrical installation costs 10,00,000
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 67

Pre-production testing 4,00,000

Purchase of a five year maintenance 7,00,000
contract with vendor

In addition to the above information XYZ Ltd. was granted a trade discount of 10% on the
initial list price of the asset and a settlement discount of 5%, if payment for the machine
was received within one month of purchase. XYZ Ltd. paid for the plant on April 20, 20X1.
At what cost the asset will be recognised?

  QUESTION 3

The term of an operating lease allows a tenant, XYZ Ltd. to tailor the property to meet
its specific needs by building an additional internal wall, but on condition that the tenant
returns the property at the end of the lease in its original state. This will entail dismantling
the internal wall. XYZ Ltd. incurs a cost of `25,00,000 on building the wall and present
value of estimated cost to dismantle the wall is ` 10,00,000. At what value should the
leasehold improvements be capitalised in the books of XYZ Ltd.

SOLUTION
The leasehold improvement is not only the cost of building the wall, but also the cost of
restoring the property at the end of the lease. As such both costs i.e., `35,00,000 are
capitalised when the internal wall is built and will be recognised in profit and loss over the
useful life of the asset (generally the lease term) as a part of depreciation charge).

  QUESTION 4 (ACQUISITION OF ASSETS)

X Limited started construction on a building for its own use on April 1, 20X0. The following
costs are incurred:

`
Purchase price of land 30,00,000
Stamp duty & legal fee 2,00,000
Architect fee 2,00,000
Site preparation 50,000
Materials 10,00,000
Direct labour cost 4,00,000
General overheads 1.00.000

Other relevant information: Material costing ` 1,00,000 had been spoiled and therefore
wasted and a further ` 1,50,000 was spent on account of faulty design work. As a result of
 68 IND AS 16: PROPERTY, PLANT & EQUIPMENT

these problems, work on the building was stopped for two weeks during November 20X0
and it is estimated that ` 22,000 of the labour cost relate to that period. The building
was completed on January 1, 20X1 and brought in use April 1, 20X1. X Limited had taken
a loan of ` 40,00,000 on April 1, 20X0 for construction of the building (which meets the
definition of qualifying asset as per Ind AS 23). The loan carried an interest rate of 8% per
annum and is repayable on April 1, 20X2.
Calculate the cost of the building that will be included in tangible non-current asset as an
addition?

  QUESTION 5 (CHANGE IN ESTIMATED LIFE)

XYZ Ltd. purchased an asset on January 1, 20X0, for ` 1,00,000 and the asset had an
estimated useful life of ten years and a residual value of ` nil. The company has charged
depreciation using the straight-line method at ` 10,000 per annum. On January 1, 20X4,
the management of XYZ Ltd. Reviews the estimated life and decides that the asset will
probably be useful for a further four years and, therefore, the total life is revised to eight
years. How should the asset be accounted for remaining years?

  QUESTION 6 (ACQUISITION OF ASSETS)

On 1 April 20X1, Sun ltd purchased some land for ` 10 million (including legal costs of ` 1
million) in order to construct a new factory. Construction work commenced on 1 May 20X1.
Sun ltd incurred the following costs in relation with its construction:

- Preparation and levelling of the land – ` 3,00,000.

- Purchase of materials for the construction – ` 6·08 million in total.
- Employment costs of the construction workers – ` 2,00,000 per month.
- Overhead costs incurred directly on the construction of the factory – `1,00,000 per
month.
- Ongoing overhead costs allocated to the construction project using the company’s normal
overhead allocation model- ` 50,000 per month.
- Income received during the temporary use of the factory premises as a car park during
the construction period - ` 50,000.
- Costs of relocating employees to work at the new factory- ` 300,000.
- Costs of the opening ceremony on 31 January 20X1- ` 150,000.

The factory was completed on 30 November 20X1 and production began on 1 February
20X2. The overall useful life of the factory building was estimated at 40 years from the
date of completion. However, it is estimated that the roof will need to be replaced 20 years
after the date of completion and that the cost of replacing the roof at current prices would
be 30% of the total cost of the building.
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 69

At the end of the 40 -year period, Sun ltd has a legally enforceable obligation to demolish
the factory and restore the site to its original condition. The directors estimate that the
cost of demolition in 40 years’ time (based on prices prevailing at that time) will be ` 20
million. An annual risk adjusted discount rate which is appropriate to this project is 8%. The
present value of `1 payable in 40 years’ time at an annual discount rate of 8% is 4·6 cents.
The construction of the factory was partly financed by a loan of ` 17·5 million taken out
on 1 April 20X1. The loan was at an annual rate of interest of 6%. During the period 1
April 20X1 to 31 August 20X1 (when the loan proceeds had been fully utilised to finance
the construction), Sun Ltd received investment income of ` 100,000 on the temporary
investment of the proceeds.
Required:
Compute the carrying amount of the factory in the Balance Sheet of Sun Ltd at 31 March
20X2. You should explain your treatment of all the amounts referred to in this part in your
answer.

  QUESTION NO 7 (REPAIRS & REPLACEMENT)

XYZ Ltd. has acquired a heavy road transporter at a cost of ` 1,00,000 (with no breakdown
of the component parts). The estimated useful life is 10 years. At the end of the sixth year,
the power train (one of its component) requires replacement, as further maintenance is
uneconomical due to the off-road time required. The remainder of the vehicle is perfectly
roadworthy and is expected to last for the next four years. The cost of a new power train
is ` 45,000.
Can the cost of the new power train be recognized as an asset, and, if so, what treatment
should be used?

  QUESTION NO 8 (ACQUISITION OF ASSETS)

ABC Ltd. is installing a new plant at its production facility. It has incurred these costs:

1 Cost of the plant (cost per supplier’s invoice plus taxes) ` 25,00,000
2 Initial delivery and handling costs ` 2,00,000
3 Cost of site preparation ` 6,00,000
4 Consultants used for advice on the acquisition of the plant ` 7,00,000
5 Interest charges paid to supplier of plant for deferred credit ` 2,00,000
6 Estimated dismantling costs to be incurred after 7 years ` 3,00,000
7 Operating losses before commercial production ` 4,00,000

Please advise ABC Ltd. on the costs that can be capitalized in accordance with Ind AS 16.
 70 IND AS 16: PROPERTY, PLANT & EQUIPMENT

  QUESTION NO 9 (REVALUATION OF ASSETS)

A Ltd. has an item of plant with an initial cost of ` 1,00,000. At the date of revaluation,
accumulated depreciation amounted to ` 55,000. The fair value of the asset, by reference
to transactions in similar assets, is assessed to be ` 65,000.
Pass Journal Entries with regard to Revaluation?

  QUESTION NO 10 (CHANGE IN ESTIMATED LIFE)

B Ltd. owns an asset with an original cost of ` 2,00,000. On acquisition, management

determined that the useful life was 10 years and the residual value would be ` 20,000. The
asset is now 8 years old, and during this time there have been no revisions to the assessed
residual value.
At the end of year 8, management has reviewed the useful life and residual value and has
determined that the useful life can be extended to 12 years in view of the maintenance
program adopted by the company. As a result, the residual value will reduce to ` 10,000.
How would the above changes in estimates be made by B Ltd.?

  QUESTION NO 11

X Ltd. has a machine which got damaged due to fire as on January 31, 20X1. The carrying
amount of machine was ` 1,00,000 on that date. X Ltd. sold the damaged asset as scrap
for ` 10,000. X Ltd. has insured the same asset against damage. As on March 31, 20X1, the
compensation proceeds was still in process but the insurance company has confirmed the
claim. Compensation of ` 50,000 is receivable from the insurance company. How X Ltd. will
account for the above transaction?

  QUESTION NO 12 (CHANGE IN DECOMMISSIONING COST)

An entity has a nuclear power plant and a related decommissioning liability. The nuclear
power plant started operating on April 1, 2017. The plant has a useful life of 40 years. Its
initial cost was ` 1,20,000 which included an amount for decommissioning costs of ` 10,000,
which represented ` 70,400 in estimated cash flows payable in 40 years discounted at a
risk-adjusted rate of 5 per cent. The entity’s financial year ends on March 31. On March,
value of the decommissioning liability has decreased by ` 8,000. The discount rate has not
yet changed.
How the entity will account for the above changes in decommissioning liability if it adopts
cost model?
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 71

  QUESTION NO 13 (CHANGE IN DECOMMISSIONING COST)

An entity has a nuclear power plant and a related decommissioning liability. The nuclear
power plant started operating on April 1, 20X1. The plant has a useful life of 40 years. Its
initial cost was ` 1,20,000.; This included an amount for decommissioning costs of ` 10,000,
which represented ` 70,400 in estimated cash flows payable in 40 years discounted at a
risk-adjusted rate of 5 per cent. The entity’s financial year ends on March 31. Assume that
a market-based discounted cash flow valuation of ` 1,15,000 is obtained at March 31, 20X4.
It includes an allowance of ` 11,600 for decommissioning costs, which represents no change
to the original estimate, after the unwinding of three years’ discount. On March 31, 20X5,
the entity estimates that, as a result of technological advances, the present value of the
decommissioning liability has decreased by ` 5,000. The entity decides that a full valuation
of the asset is needed at March 31, 20X5, in order to ensure that the carrying amount does
not differ materially from fair value. The asset is now valued at ` 1,07,000, which is net of
an allowance for the reduced decommissioning obligation.
How the entity will account for the above changes in decommissioning liability if it adopts
revaluation model ?

  QUESTION 14- REPLACEMENT COST

Sun Ltd has acquired a heavy road trailer at a cost of ` 100,000 (with no breakdown of
component parts). The estimated useful life is 10 years. At the end of the sixth year, the
engine requires replacement, as further maintenance is uneconomical due to the off-road
time required. The remainder of the vehicle is perfectly road worthy and is expected to
last for the next four years. The cost of the new engine is ` 45,000. The discount rate
assumed is 5%.
Whether the cost of new engine can be recognised as the asset, and if so, what treatment
should be followed?

SOLUTION
For recognition of an item as property, plant and equipment, the recognition condition needs
to be satisfied:

(a) future economic benefits associated with the asset should flow to the entity and
(b) cost can be measured reliably.
The new engine will produce economic benefits to the Company and cost of the engine can
be measured reliably. Hence, the item should be recognised as the asset.
The cost of ` 45,000 of new engine will be added to the carrying amount.
The original invoice of the trailer did not specify the cost of the engine. Therefore, the
cost of replacement ` 45,000 will used as indicative price and discount to year 1,
 72 IND AS 16: PROPERTY, PLANT & EQUIPMENT

6
1
i.e., (45,000 x = = 33,580
1.05

Revised Cost = (100,000 - 33,580 + 45,000) = 111,420

  QUESTION NO 15 (INSPECTION COST)

A shipping company is required by law to bring all ships into dry dock every five years for
a major inspection overhaul. Overhaul expenditure might at first sight seem to be a repair
to the ships but it is actually a cost incurred in getting the ship back into a seaworthy
condition. As such the costs must be capitalized.
A ship which cost ` 20 million with a 20 year life must have major overhaul every five years.
The estimated cost of the overhaul at the five-year point is ` 5 million.

  QUESTION 16 - DEFERRED PAYMENT CREDIT

On 1st April 20X1, an item of property is offered for sale at ` 10 million, with payment terms
being three equal installments of ` 33,33,333 over a two years period (payments are made
on 1st April 20X1, 31st March 20X2 and 31st March 20X3).
The property developer is offering a discount of 5 percent (i.e. ` 0.5 million) if payment is
made in full at the time of completion of sale. Implicit interest rate of 5.36 percent p.a.
Show how the property will be recorded in accordance of Ind AS 16.

  QUESTION 17 – EXCHANGE OF ASSETS

Pluto Ltd owns land and building which are carried in its balance sheet at an aggregate
carrying amount of ` 10 million. The fair value of such asset is ` 15 million. It exchanges the
land and building for a private jet, which has a fair value of ` 18 million, and pays additional
` 3 million in cash.
Show the necessary treatment as per Ind AS 16.

  QUESTION 18 ACCUMULATED DEPRECIATION AT THE DATE OF

 REVALUATION

Jupiter Ltd. has an item of plant with an initial cost of ` 100,000. At the date of revaluation
accumulated depreciation amounted to ` 55,000. The fair value of asset, by reference to
transactions in similar assets, is assessed to be ` 65,000.
Find out the entries to be passed?
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 73

  QUESTION 19: REVALUATION MODEL FOR ENTIRE CLASS

Venus Ltd. is a large manufacturing group. It owns a considerable number of industrial

buildings, such as factories and warehouses, and office buildings in several capital cities.
The industrial buildings are located in industrial zones whereas the office buildings are in
central business districts of the cities. Venus’s Ltd. management want to apply the Ind AS
16 revaluation model to the subsequent measurement of the office buildings but continue
to apply the historical cost model to the industrial buildings. Is this acceptable under Ind
AS 16, Property, Plant and Equipment?

  QUESTION 20 UTILISATION OF REVALUATION SURPLUS

An item of PPE was purchased for ` 9,00,000 on 1 April 20X1. It is estimated to have a
useful life of 10 years and is depreciated on a straight line basis. On 1 April 20X3, the asset
is revalued to ` 9,60,000. The useful life remains unchanged at ten years.
Show the necessary treatment as per Ind AS 16.
 74 IND AS 16: PROPERTY, PLANT & EQUIPMENT

PAST EXAMINATION QUESTIONS

QUESTION 1 NOVEMBER 2018 EXAM

On 1st April, 2017 Good Time Limited purchase some land for ` 1.5 crore (including legal
cost of ` 10 lakhs) for the purpose of constructing a new factory. Construction work
commenced on 1st May, 2017 Good Time Limited incurred the following costs in relation to
its construction.
  `
Preparation and levelling of the land 4,40,000
Purchase of materials of the construction 92,00,000
Employment costs of the construction workers (per month) 1,45,000
Overhead costs incurred directly on the construction of the factory
 
(per month)
Ongoing overhead costs allocated to the construction project (using he
1,25,000
company’s normal overhead allocation model) per month
Costs of relocating employees to work at new factory  
Costs of the opening ceremony on 1st January, 2018 75,000
Income received during the temporary use of the factory premises as a
3,25,000
store during the construction period.
  2,50,000
  60,000
The construction of the factory was completed on 31st December, 2017 and production
began on 1st February, 2018. The overall useful life of the factory building was estimated
at 40 years from the date of completion. However, it is estimated that the roof will need
to be replaced 20 years after the date of completion and that the cost of replacing the
roof at current prices would be 25% of the total cost of the building.
At the end of the 40 years period, Good Time Limited has a legally enforceable obligation
to demolish the factory and restore the site to its original condition, The company
estimates that the cost of demolition in 40 years time (based on price prevailing at that
time) will be ` 3 crore. The annual risk adjusted discount rate which is appropriate to this
project is 8% The present value of ` 1 payable in 40 years time at an annual discount rate
of 8% is 0.046.
The construction of the factory was partly financed. by a loan of ` 1.4 crore taken out on
1st April, 2017. The loan was at an annual rate of interest of 9% During the period 1st April,
2017 to 30th September, 2017 (when the loan proceeds had been fully utilized to finance
the construction), Good Time Limited received investment income of ` 1,25,000 on the
temporary investment of the proceeds.
You are required to compute the cost of the factory and the carrying amount of the
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 75

factory in the Balance Sheet of Good Time Limited as at 31st March, 2018.

ANSWER
Computation of the cost of the factory
  `
Purchase of land 1,50,00,000
Preparation and levelling 4,40,000
Materials 92,00,000
Employment costs of construction workers (1,45,000 x 8 months) 11,60,000
Direct overhead costs (1,25,000 x 8 months) 10,00,000
Allocated overhead costs Nil
Income from use of a factory as a store Nil
Relocation costs Nil
Costs of the opening ceremony Nil
Finance costs 9,45,000
Investment income on temporary investment of the loan proceeds -1,25,000
Demolition cost recognised as provision (3,00,00,000 x 0.046) 13,80,000
Total 2,90,00,000

Computation of carrying amount of the factory as at 31st March,2018

  Land Factory
(Non-depre-
ciable asset)
(Depreciable
asset)

Cost of the asset (Total cost 2,90,00,000)   1,50,00,000 1,40,00,000

Less: Depreciation      
On Land   Nil  
On Factory      

Depreciation on roof component (1,40,00,000

43,750    
x 25% x 1/20 x 3/12)

Depreciation on remaining factory (1,40,00,000

     
x 75% x 1/40 x 3/12)

  65,625   -1,09,375
 76 IND AS 16: PROPERTY, PLANT & EQUIPMENT

 
Carrying amount of depreciable asset ie fac-
   
tory

Total cost   1,50,00,000 1,38,90,625

      2,88,90,625
Note
1. Interest cost has been capitalised based on nine month period. This is because, pur-
chase of land would trigger off capitalisation.
2. All of the net finance cost ` 8,20,000 (` 9,45,000 – ` 1,25,000) has been allocated to
the depreciable asset i.e Factory. Alternatively, it can be allocated proportionately
between land and factory.

QUESTION 2 NOVEMBER 2019 EXAM

M Ltd. is setting up a new factory outside the Delhi city limits. In order to facilitate the
construction of the factory and its operations, M Ltd. is required to incur expenditure on
the construction/ development of electric-substation. Though M Ltd. incurs (or contributes
to) the expenditure on the construction/development, it will not have ownership rights
on these items and they are also available for use to other entities and public at large.
Whether M Ltd. can capitalise expenditure incurred on these items as property, plant
and equipment (PPE)? If yes, then how should these items be depreciated and presented
in the financial statements of M Ltd. as per Ind AS?

ANSWER
As per Ind AS 16, the cost of an item of property, plant and equipment shall be recognised
as an asset if, and only if:
1. it is probable that future economic benefits associated with the item will flow to the
entity; and
2. the cost of the item can be measured reliably.
Ind AS 16, further, states that the cost of an item of property, plant and equipment
comprise any costs directly attributable to bringing the asset to the location and condition
necessary for it to be capable of operating in the manner intended by management.
In the given case, electric-substation is required to facilitate the construction of the
refinery and for its operations. Expenditure on these items is required to be incurred in
order to get future economic benefits from the project as a whole which can be considered
as the unit of measure for the purpose of capitalisation of the said expenditure even
though the company cannot restrict the access of others for using the assets individually.
It is apparent that the aforesaid expenditure is directly attributable to bringing the asset
to the location and condition necessary for it to be capable of operating in the manner
intended by management.
 IND AS 16: PROPERTY, PLANT & EQUIPMENT 77

In view of this, even though M Ltd. may not be able to recognise expenditure incurred on
electric-substation as an individual item of property, plant and equipment in many cases
(where it cannot restrict others from using the asset), expenditure incurred may be
capitalised as a part of overall cost of the project.
From this, it can be concluded that, in the extant case the expenditure incurred on electric-
substation should be considered as the cost of constructing the factory and accordingly,
expenditure incurred on electric-substation should be allocated and capitalised as part of
the items of property, plant and equipment of the factory.
Depreciation
As per Ind AS 16, each part of an item of property, plant and equipment with a cost that
is significant in relation to the total cost of the item shall be depreciated separately.
Further, Ind AS 16 provides that, if these assets have a useful life which is different
from the useful life of the item of property, plant and equipment to which they relate, it
should be depreciated separately. However, if these assets have a useful life and the
depreciation method that are the same as the useful life and the depreciation method
of the item of property, plant and equipment to which they relate, these assets may be
grouped in determining the depreciation charge. Nevertheless, if it has been included
in the cost of property, plant and equipment as a directly attributable cost, it will be
depreciated over the useful lives of the said property, plant and equipment.
The useful lives of electric-substation should not exceed that of the asset to which it
relates.
78 IND AS 16: PROPERTY, PLANT & EQUIPMENT

NOTES
 IND AS 23: BORROWING COST 79

IND AS 23: BORROWING COST

CONCEPT 1: APPLICATION OF IND AS 23

Entities are borrowing the funds to acquire, build and install the fixed assets and other
assets, these assets take time to make them useable or saleable, therefore the entity
incur the interest (cost on borrowings) to acquire and build these assets. The objective
of this Ind AS is to prescribe the treatment of borrowing cost (interest+ other cost) in
accounting, whether the cost of borrowing should be included in the cost of assets or not.

CONCEPT 2: NON-APPLICABILITY
This Standard does not apply:

• Cost of owner’s equity, including preference share capital not classified as a liability:
• A qualifying asset measured at fair value, for example, biological asset: or
• Inventories that are manufactured or other otherwise produced in large quantities on a
repetitive basis.

CONCEPT 3: MEANING OF BORROWING COST

Borrowing costs are defined as interest and other costs incurred relating to borrowing of
funds. It includes the following costs or charges:

• Interest expenses calculated using the effective interest rate method.

• Finance charges when the asset acquired under finance leases.
• Exchange difference arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs.

CONCEPT 4: EFFECTIVE INTEREST RATE METHOD

The effective interest rate is the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument to make it equal
to the net carrying amount of the financial liability. This is somewhat akin to internal rate
of return.
When applying the effective interest method, an generally amortize any fees, points paid
or receive transaction costs and other premium or discounts included in the calculation of
the effective interest rate over the expected life of the instrument. However, shorter
period is used if this is the period which the fees, points paid or received, transaction costs
premiums or discounts relate.
 80 IND AS 23: BORROWING COST

Example 1:
X Ltd borrowed for 5 years by issuing 10% debentures of ` 100 each having total face value
of ` 1,000 crore issued at discount and collected ` 990.58 crores. The issued expenses
were ` 10 lakhs, which were paid at the time of issue. What will be effective interest rate
on these borrowing?
The debentures are issued at a discount further issue expenses of ` 10 lakhs has also been
incur the effective interest rate will be higher than the coupon rate of 10% by applying the
formula- PV = FV/(i+r)n, The effective rate comes 10.25%
The correctness of this effective interest rate is tested below as the future cash outflow
discounted @10.25% is equal to cash inflow by issuing the debentures.

Year Cash inflow Future Cash Discount rate Discounted cash

(Net carrying outflow interest + @10.25% outflow (Amount in
amount) Principal crores)
0 (990.58-0.10)
=990.48
1 100 0.9070 90.70
2 100 0.8230 82.30
3 100 0.7462 74.62
4 100 0.6768 67.68
5 1100 0.6138 675.18
990.48 990.48

Net Cash inflow received on account of borrowings from debenture is equal to present value
of cash outflow on account of interest ` 100 crores every year and in 5th year ` 1100 crores
including principal repayment.

CONCEPT 5: DIRECT BORROWING COST

As per this Ind AS, borrowing cost, which is directly attributable to the acquisition,
construction or production of qualifying asset should be capitalized as part of cost of the
asset. Other borrowing costs are recognized as expenses.

CONCEPT 6: QUALIFYING ASSET

An asset which takes substantial period of time to get ready for its intended use or sale,
is called qualifying asset.
 IND AS 23: BORROWING COST 81

Examples of qualifying assets:

- Any tangible fixed assets, which are in construction process or acquired tangible fixed
assets, which are not ready for use or resale such as plants and machinery.
- Any intangible assets, which are in development phase or acquired but not ready for use
or resale, such as patent.
- Investment property.
- Inventories that require a substantial period (i.e. generally more than one accounting
period) to bring them to a saleable condition.
Following are the examples which are not qualifying assets:
- Financial asset;
- Inventories that are manufactured, or otherwise produced, over a short period of time;
- Assets which are ready for their intended use or sale when acquired.

CONCEPT 7: CONDITIONS FOR CAPITALIZATION

OF BORROWING COST
Following conditions should be satisfied for capitalization of borrowing costs:

 Those borrowing costs, which are directly attributable to the acquisition, construction
or production of qualifying asset, are eligible for capitalization. Directly attributable
costs are those costs that would have been avoided if the expenditure on the qualifying
asset had not been made.
 Qualifying assets will give future economic benefit to the enterprise and the cost can
be measured reliably.

CONCEPT 8: AMOUNT OF BORROWING COSTS ELIGIBLE

FOR CAPITALIZATION

• Specific borrowing-

Amount of borrowing cost to the = Actual borrowing cost incurred

capitalized (Amount borrowed is during the period less any income
specifically for the purchase of on the temporary investment of
qualifying assets) borrowed amount.

Example 2:
X Ltd borrowed for 5 years by issuing 10% debentures of ` 100 each having total face of `
1,000 crores, issued at discount and collected ` 990.58 crores. The issued expenses were
 82 IND AS 23: BORROWING COST

` 10 lakhs, which were paid at the time of issue. Effective rate of interest is 10.25%. It
is specific borrowing for investment in a power plant. Since presently there is requirement
for only 50% of the moray raised and the balance will be required after 6 months of Year
1, the Company invested such fund temporarily for 6 months @ 4% p.a. The plant is under
construction during the Year.
How much of the borrowing cost to be capitalized in year 1
Borrowing cost to be capitalized in Year 1
Interest expense as per effective interest rate method
(` 990.48 crores @ 10.25%) ` 101.52 crores
Less : Investment income 4% of (9904.48 x 50% x 1/2) 9.90 crores
Borrowing cost to be capitalized 91.62 crores

CONCEPT 9: GENERAL BORROWINGS

When the amount borrowed is generally used for the purpose of obtaining qualifying asset:
- Amount of borrowing cost to be capitalized should be determined by applying a
capitalization rate to the expenditure on that asset. The capitalization rate should be
weighted average of borrowing cost.
- Amount of borrowing cost capitalized during a period should not exceed the amount of
borrowing cost incurred during that period.
- The average carrying amount of the asset during a period including borrowing cost
previously capitalized, is normally a reasonable approximation of the expenditure to
which capitalization rate is applied in that period.
Linking borrowing costs relating to general borrowings to qualifying assets:

• Find out qualifying asset in which general borrowings are applied and total investment
therein
• Deduct specific borrowings used to finance such investments. Balance is the utilization
of general borrowings
• Find out general borrowings
• Find out capitalization = Total borrowing costs to general borrowings
• Apportion borrowing costs relating to general borrowings = Total Investment
Requirements Capitalization Rate
• Charges the apportioned borrowings cost in the ratio of investment requirements in
various qualifying assets
• Charges specific borrowing cost net of investment income
• Apportioned general borrowings cost + specific borrowing costs net of investment income
 IND AS 23: BORROWING COST 83

CONCEPT 10: COMMENCEMENT OF CAPITALIZATION

OF BORROWING COST
Following three conditions must be fulfilled before the commencement of capitalization of
borrowing cost:
• Activities, which are essential to prepare the asset for its intended use, should be in
progress.
• Borrowing cost is incurred.
• Expenditure for acquisition, construction or production of a qualifying asset is being
incurred.

CONCEPT 11: EXPENDITURE ON QUALIFYING ASSET

• Expenditure includes payment of cash, transfer of other asset or assumption of interest

bearing liabilities.
• Progress payment received and grant received towards the cost incurred should be
deducted from the expenditure.

CONCEPT 12: SUSPENSION OF CAPITALIZATION

OF BORROWING COST
Capitalization of borrowing costs should be suspended during extended periods in which
active development is interrupted.
Capitalization of borrowing costs is not suspended when a temporary delay is a necessary
part of the process of getting an asset ready for its intended use or sale.

CONCEPT 13: CESSATION OF CAPITALIZATION

 Capitalization of borrowing cost should cease when substantially all the

activities necessary to prepare the qualifying assets for its intended use or sale are
completed.
It means all relevant activities, which are essential for intended use or sale of qualifying
assets, should be completed.
 Construction of the qualifying asset is carried in parts/phase and each part/phase
can be used independently, required activities are completed for such phase and it is
ready for intended use or sale, capitalization of borrowing cost for such phase/part will
cease.
 84 IND AS 23: BORROWING COST

CONCEPT 14: DISCLOSURE

An entity shall disclose:

 The amount of borrowing cost capitalized during the period.

 The capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.

CONCEPT 15: EXCHANGE DIFFERENCES PARA 6E

Ind AS-23, “Borrowing Costs”, provides that borrowing costs may include “exchange
differences arising from foreign currency borrowings to the extent that they are regarded
as an adjustment to interest costs.” The manner of arriving at the adjustments stated
therein shall be as follows:

• The adjustment should be of an amount which is equivalent to the extent to which

the exchange loss does not exceed the difference between the cost of borrowing in
functional currency when compared to the cost of borrowing in a foreign currency.
• Where there is an unrealized exchange loss which is treated as an adjustment to interest
and subsequently there is a realized or unrealized gain in respect of the settlement
or translation of the same borrowing, the gain to the extent of the loss previously
recognized as an adjustment should also be recognized as an adjustment to interest.
 IND AS 23: BORROWING COST 85

PRACTICAL PROBLEMS

  QUESTION NO 1 (PROGRESS PAYMENT)

Given below are some relevant data as regards a construction contract.

Rs. In lacs
Expenditure incurred till 31.3.2000 450
Interest cost capitalized for the year 1999-2000 @ 12% p.a. 24
Amount specifically borrowed till 31.3.2000 200
Assets transferred to construction during 2000-01 100
Cash payments during 2000-01 78
Progress payment received 300
New borrowings during 2000-01 @ 12% 200

The company intends to capitalize total borrowing cost of Rs.48 lacs. Is it possible to do
that as per IND AS 23?

  QUESTION NO 2 (CESSATION IN PARTS)

Given below are expenses incurred in three phases of a project relating to construction of
a captive power plant:
(Rs.)

Phase 1 Phase 2 Phase 3 Total

Cash payments 500000 700000 500000
Transfer of assets 500000 200000 300000
Total 1000000 900000 800000 2700000

Money borrowed at the rate of 12% per annum is Rs.2200000.

The phase 1 is complete. How should the company capitalize borrowing costs?

  QUESTION NO 3

Borrowing cost on the loans taken specifically to construct captive power plant is being
capitalized even after the commencement of commercial production. The management
argues that the borrowing cost is attributable solely and exclusively captive power plant
and therefore should be capitalized. Give comment
 86 IND AS 23: BORROWING COST

  QUESTION NO 4 (DEFINITION OF Q.ASSETS)

Parveen Jindal Limited obtained term loan during the year ended 31st March, 2002 Ltd.
uses extent of Rs.650lacs for modernization and development of its factory. Building worth
Rs.120lacs were completed and plant and machinery worth Rs.350 lacs were installed by
31st March, 2002. A sum of Rs.70 lacs has been advanced for Assets the installation of
which is expected in the following year. Rs.110 lacs have been utilized for working capital
requirements. Interest paid on the loan of Rs.650 lacs during the year 2001-2002 amounted
to Rs.58.50 lacs. How should the interest amount be treated in the Accounts of the company?

  QUESTION NO 5 (CAPITALISATION RATE)

C Limited has made the following capital expenditure in an expansion programme commencing
from 1.6.2001:-

Project Remarks Amount Status

A Specific borrowings used 34,00,00,000 Completed on 31.12.01
Rs.24,00,00,000
B Specific borrowing used 20,00,00,000 Completed on 30.11.01
Rs.6,00,00,000
C 4,00,00,000 Under construction
D. 4,00,00,000 Completed on 28.2.02
E 8,00,00,000 Under construction

Details of borrowings:
Rs.20,00,00,000 11% Debentures issued on 1.7.99 redeemable in four equal installments
commencing from 1.7.2001.
Rs.15,00,00,000 14% secured working capital loan taken on 1.4.01 and Rs.5,00,00,000 was
paid on 31.12.2001
Rs.30,00,00,000 14% specific borrowings for projects A and B taken on 1.5.2001
$6,000,000 8% foreign currency loan taken on 1.6.2001 Exchange rate as of that date
was US$1= Rs.43.00. The exchange rate as of March 31, 2001 was US$1= Rs.46.5. Average
exchange rate= Rs.45/-
Calculate the amount of borrowing costs to the capitalized during the year 2001-2002

  QUESTION NO 6 (DEFINITION OF Q.ASSETS)

R Ltd. has borrowed Rs.25 crores from financial institution during the financial year 2001-
02. These borrowings are used to invest in shares of A Ltd , a subsidiary company, which
 IND AS 23: BORROWING COST 87

is implementing a new project estimated to cost 50 crores. As on 31st march,2002 since

the said project was not yet complete, the directors of R ltd, resolved to capitalize the
interest on the borrowings amounting to Rs.3 crores and add it to the cost of investments.
As a statutory auditor, please comment.

  QUESTION NO 7 (DATE WISE CAPITALISATION)

XYZ Ltd. Has undertaken a profit for expansion of company of capacity as per the following
details;

Plan (RS.) Actual (RS.)

April 2002 2,00,000 2,00,000
May 2002 2,00,000 3,00,000
June 2002 10,00,000 ---
July 2002 1,00,000 ---
August 2002 2,00,000 1,00,000
September 2002 5,00,000 7,00,000

The company pays to its bankers at the rate of 12% p.a., interest being debited on a monthly
basis. During the half year company had Rs.10 lakhs overdraft upto 31st July, surplus cash in
August and again overdraft of over Rs.10 lakhs from 01-09-2002. The company had a strike
during June and hence could not continue the work during June. Work was again commenced
on 1st July and all the works were completed on 30th September. Assume that expenditure
were incurred on 1st Day of each month. Calculate:
1. Interest to be capitalized
2. Give reasons wherever necessary.

  QUESTION NO 8

G company has incurred an amount of Rs.80 lakhs as borrowing cost during the year ended
31.12.2002 calculated as under:

Amount borrowed Date on which Amount Interest

borrowing is made (Rs. in lacs)
14%Debentures 1.12.2001 200 28
12%Term loan 1.12.2001 300 36
16% Secured loan 1.10.2002 400 16
 88 IND AS 23: BORROWING COST

The 16% secured loan has been specifically raised for construction of factory building. The
plant is likely to be completed in two years. The other qualifying assets & expected time to
complete the assets in which these funds have been utilized are:
Plant 1 200Lacs 18 months
Internal roads 100Lacs 14 months
Plant 11 100Lacs 20 months
Compute the amount of borrowing costs to be capitalized for the year ended 31.3.2002.

  QUESTION NO 9

ICS & company is a sugar company. Due to the regulations by Central Government, the
company cannot decide the quantity to be sold in the market. It is regulated on the basis
of release orders issued by the Central government on a monthly basis. Because of the
seasonal nature of production, the company has to carry large inventories throughout the
year. The average holding period of the sugar stock is generally 12-15 months. In the years
when there is surplus stock of sugar, the government creates a buffer stock and reimburses
the carrying charges to the sugar factories, for the inventory to be carried by the sugar
mill, which includes interest. Sweet & company incurs high interest costs since borrowings
are required to meet the large demand for the working capital and payment to sugarcane
producers. Interest costs are the second largest item in the Profit and Loss account of the
company next to raw material consumed. Can interest be capitalized under IND AS-23 as
a part of inventory.

  QUESTION NO 10

The main object of a company is to undertake plantation activities, raising of teak and other
forestry operations. It takes about 10 to 15 years for the teak trees to grow. The company
has issued Debentures for the fund to meet all the expenses. The company included all cost
of planetary and interest paid in the valuation of stock of teak. Give comment.

  QUESTION NO 11

In may, 2004 speed Ltd. took a bank loan to be used specifically for the construction of a
new factory building. The construction was completed in January 2005 and the building was
put to its use immediately thereafter. Interest on the actual amount used for construction
of the building till its completion was Rs.18 lakhs, whereas the total interest payable to the
bank on the loan for the period till 31st March,2005 amounted to Rs.25 lakhs. Can Rs.25
lakhs be treated as a part of the cost of factory building and thus be capitalized on the plea
that the loan was specifically taken for the construction of factory building.
 IND AS 23: BORROWING COST 89

  QUESTION NO 12 (EXPECTED COST OF COMPLETION)

A fixed asset is in the construction period. Actual costs incurred till date and expected
costs to complete along with borrowings and planned borrowings are given below:
(Rs. in lacs)

Year Actual Estimated Money specifically Planned

borrowed borrowings
1 100 60
2 100 60
3 80 40
4 60 40
5 50 30

Borrowed funds costs @ of 12% per annum. Determine the estimated cost of the asset at
the end of 5th year.

  QUESTION NO 13

Advise X Ltd. on the weighted average cost of borrowing and the interest cost to be
capitalized based on the following:
Total borrowings and interest of X Ltd. for year ending 31.3.2003 are as follows:

Borrowings Date of borrowing Amount (‘000) Interest (‘000)

18% Bank loan 1.5.2001 1,000 180
14% debentures 1.10.2002 2,000 140
16% term loan 1.7.2002 3,000 360
Total 6,000 680

Qualifying assets & Actual time of work during the year in which these borrowed funds are
utilized are:

Assets Rs.(‘000) Period

Factory shed 2,500 12 months
Plant 1 1,500 9 months
Plant 2 1,000 7 months
 90 IND AS 23: BORROWING COST

  QUESTION NO 14

Determine the dates from which capitalization should cease

Building A Stage of completion
Completed in full in march
Building B Completed in full in April but not accessible until Building C is completed.
Building C Completed in December
Building D Completed in June but got electricity connection and was ready for
intended use in July.
 IND AS 23: BORROWING COST 91

QUESTIONS FOR SELF PRACTICE

  QUESTION NO 15

What do you understand by the term Borrowing costs? Briefly indicate the items
Which are included in the expression “Borrowing cost” as explained in Ind AS 23

ANSWER:
Borrowing costs are interest and other costs incurred by an enterprise In connection with
the borrowing of funds. Borrowing costs may include:

(a) Interest and commitment charges on bank borrowing and short term and long term
borrowings as per effective rate of interest method
(b) Finance charges in respective of assets acquired under finance leases or under other
similar arrangements
(c) Exchange differences arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest costs.

  QUESTION NO 16

The notes to accounts of Sharma Ltd. for the year ended 31st March includes the following
“interest on bridge loan from bank and financial institutions and on debentures specifically
obtained for the company’s fertilizer project amounting to Rs.1,80,80,000 has been
capitalized during the year, which includes approximately Rs.1,70,33,465 capitalized in
respect of the utilization of loan and debentures money for the said purpose”. Is the
treatment correct? Briefly comment

ANSWER:
For specific borrowing, amount to be capitalized = actual borrowing cost on that borrowing
during the period less income on the temporary investment of those borrowings, if any.
Hence the amount of capitalized borrowing cost can not exceed actual interest cost.
For general borrowing and use of Capitalization rate, IND AS-23 provides the amount of
borrowing costs Capitalized during a period should not exceed the amount of Borrowing
cost incurred during that period.
The given case is one of specific Borrowings for fertilizer project and hence the Capitalized
Borrowing cost is restricted to the actual amount of interest expenditure that is
Rs.1,70,33,465. Capitalization of Rs.1,80,80,000 has resulted in over statement of profit
and assets by Rs.10,46,535.
Hence the company’s policy is not in accordance with IND AS-23.
 92 IND AS 23: BORROWING COST

  QUESTION NO 17

(INCOME ON INVESTMENT MADE OUT OF BORROWED FUNDS)

Jindal Ltd. borrowed Rs.12Crores for its capital expansion which lasted for 18 months. The
relevant borrowing rate was 12.5%. During this period the company invested the temporary
surplus funds at 4.5% on short term basis and earned an interest of 25lakhs Which was
offered as miscellaneous income in the profit and loss account. The company has Capitalized
the entire interest cost and added to its plant and machinery. Is this correct?

ANSWER:
For specific borrowing, amount to be capitalized = actual borrowing cost on that borrowing
during the period less income on the temporary investment of those borrowings, if any.
In the above case, the correct accounting treatment will be:
Actual borrowing cost (12crores*12.5%*18months) = 2.25Crores
Less: interest on temporary investment = 0.25Crores
Borrowing cost to be Capitalized under IND AS-23 = 2.00Crores
The company’s treatment in crediting the amount of 0.25crores as miscellaneous income is
not proper. This amount should be used to reduce the amount of Borrowing cost eligible for
Capitalization.

  QUESTION NO 18

(CALCULATION OF COST PPE INCLUDING INTEREST)

Kapil Ltd. purchased machinery from Parveen Ltd. on 30.09.2001. The price was Rs.370.44
lakhs after charging 8% sales tax and giving a trade discount of 2% on the quoted price.
Transport charges were 0.25% on the quoted price and installation charges 1% on the
quoted price.
A loan of Rs.300 lakhs was taken on the trial from the bank on which interest at 15% per
annum was to be paid. Expenditure incurred on the trial run was materials Rs.35,000, wages
Rs.25,000 and overheads Rs.15,000.
The machinery was ready for use on 1.12.2001, but it was actually put to use only on 1.5.2002.
Find out the cost of the machine and suggest the accounting treatment for the expenses
incurred in the interval between the dates 1.12.2001 to 1.05.2002. the entire loan amount
remained unpaid on 1.5.2002.
 IND AS 23: BORROWING COST 93

ANSWER:

Particulars Computations Rs. in lakhs

Quoted price (370.44/108*100)*100/98 3,50.000
Less: discount 2% 2% of 3,50.000 7.000
Net price 3,43.000
Add: sales tax 8% 8% of 3,43.000 27.440
Add: Transportation 0.25% on quoted price of 3,50.000 0.875
Add: installation 1.00% of quoted price of 3,50.000 3.500
Add: trial run expense Material+ wages+ OH=0.35+0.25+0.15 0.750

Add: Borrowing cost 300*15%*2/12(30.9.2001 to 7.500

1.12.2001)
Total cost of asset 383.065

• Capitalization of Borrowing costs should cease when substantially all the activities
necessary to prepare the qualifying asset for its intended use are complete. In the
above case, this period ends on 1-12-2001 when the asset was ready for use.
• Other Borrowing costs (i.e, not capitalized under IND AS 23) should be written off as
an expense in the profit and loss account. Hence the interest for the period 1.12.2001
and 1.5.2002 on Rs.300 lakhs, amounting to Rs.18.75 lakhs should be expensed off.

  QUESTION NO 19 (SIMILAR AS QUESTION 4)

Sadaanand Ltd. has obtained Institutional Term Loan of Rs. 580 Lakhs for modernization
and renovation of its Plant & Machinery. Plant & Machinery acquired under the modernization
scheme and installation completed on 31st March amounted to Rs. 406 Lakhs. Rs. 58 Lakhs
has been advanced to Suppliers for additional assets and the balance loan of Rs. 116 Lakhs
has been utilized for Working Capital purpose. The accountant is in a dilemma as to how to
account for the total interest of Rs. 52.20 Lakhs incurred during the year, on the entire
Institutional Term Loan of Rs. 580 Lakhs. Give your view.

SOLUTION
52.20 Lakhs
Effective Interest Rate - = 9%.
580.00 Lakhs
The treatment for the Total Interest of Rs.52.20 Lakhs is as under:-
 94 IND AS 23: BORROWING COST

Purpose/Utilisation Loan Amt. Interest Amount Accounting Treatment

Plant & Machinery Rs. 406 Lakhs Rs. 406 x 9% Added to Cost of Plant
purchased under = Rs. 36.54 Lakhs and Machinery as per
modernization scheme IND AS 23.
Advance to Suppliers Rs. 58 Lakhs Rs. 58 x 9% Kept in Interest
for additional assets = Rs. 5.22 Lakhs Suspense A/c.
(Capital WIP A/c.) till
the date of acquisition/
installation of additional
assets & capitalized
later on asset creation.
Working Capital Rs. 116 Lakhs Rs. 116 x 9% Written off to P&L A/c.
= Rs. 10.44 Lakhs as Expense, as per IND
AS 23
Total Rs. 580 Lakhs Rs. 52.20 Lakhs

  QUESTION NO 20 (SIMILAR AS QUESTION NO 4)

Harihara Limited obtained a Loan for Rs. 70Lakhs on 15th April 20X1 from a Nationalised
Bank to be utilized as under:

Particulars Rs.
Construction of Factory Shed 25,00,000
Purchase of Machinery 20,00,000
Working Capital 15,00,000
Advance for Purchase of Truck 10,00,000

In March 20X2, Construction of the Factory Shed was completed and Machinery which was
ready for its intended use installed. Delivery of Truck was received in the next Financial
year. Total Interest RS. 9,10,000 charged by the Bank for the Financial year ending
31.03.20X1. Show the treatment of Interest under IND AS 23

SOLUTION
9.10 Lakhs
Effective Interest Rate = = 13%.
70.00 Lakhs
The treatment for the Total Interest of Rs. 9.10 Lakhs is as under:-
 IND AS 23: BORROWING COST 95

Purpose/Utilisation Loan Amt. Interest Amount Accounting Treatment

Construction of Rs. 25 Lakhs Rs. 25 x 13% Added to Cost of Factory
Factory Shed = Rs. 3.25 Lakhs Shed as per IND AS 23

Purchase of Rs. 20 Lakhs Rs. 20 x 13% Added to Cost of Machinery

Machinery = Rs. 2.60 Lakhs as per IND AS 23

Working Capital Rs. 15 Lakhs Rs. 15 x 13% Written off to P&L A/c. as
= Rs. 1.95 Lakhs Expense, as per IND AS 23

Advance to Rs. 10 Lakhs Rs. 10 x 13% Kept in Interest Suspense

Supplier for = Rs. 1.30 Lakhs A/c. (Capital WIP A/c) till
Purchase of Truck the date of acquisition/
installation of Truck &
capitalized later on asset
creation. (Assumed as
Qualifying Asset)
Total Rs. 70 Lakhs Rs. 9.10 Lakhs

  QUESTION NO 21

On 1st April, Aruna Construction Ltd. obtained a loan of Rs. 32 Crores to be utilized as
under:-

Particulars Rs. in Particulars Rs. in

Crores Crores

Construction of Sea link across 2 25.00 Working Capital 2.00

cities (work was held up totally Purchase of Vehicles 0.50
for a month during the year due Advance for Tools/Cranes,etc. 0.50
to high water levels) Purchase of Technical know- 1.00
How
Purchase of Equipment’s and 3.00
Machineries

Total Interest charged by the Bank for the relevant financial year in Rs. 80 Lakhs. Show
the treatment of Interest by Aruna Construction Ltd. under IND AS 23
 96 IND AS 23: BORROWING COST

SOLUTION
80.00 Lakhs
Effective Interest Rate = = 2.5%.
3,200.00 Lakhs
The treatment for the Total Interest of Rs. 80 Lakhs is as under:-
Note: Interest Amount = Loan Amount = 2.5% Both Amounts in Rs. Lakhs

Purpose/Utilisation Loan Amt. Interest Accounting Treatment

Amount
1. 
Construction of Sea- 2,500 62.50 Added to Cost of Asset (It is
Link across two cities assumed that during temporary
suspension, some Administrative
Activities were carried on)
2. Purchase of 300 7.50 Added to Cost of Equipments and
Equipments & M/c. Machineries
3. Working Capital 200 5.00 Written off to P&L A/c. as
Expense. IND AS 23
4. Purchase of Vehicles 50 1.25 Debited to P&L A/c. (Assumed
immediate delivery taken and it
is ready for use and hence not a
Qualifying Asset)
5. Advance for Tools/ 50 1.25 Kept in Interest Suspense A/c.
Cranesetc. (Capital WIP A/c) till the date
of acquisition/installation of
the Assets & capitalized later.
(Assumed as Qualifying Asset)
6. Purchase of 100 2.50 Added to the cost of Intangibles.
Technical Know-how
Total Borrowing Cost 3,200.00 80.00

  QUESTION NO 22 (SIMILAR AS Q.2)

Hariram Iron and Steel Ltd. is establishing an Integrated Steel Plant consisting of four
phases. It is expected that the full Plant will be established over several years but Phase
I and Phase II will be started as soon as they are completed.
Following are the details of work done on different phases of the Plant during the current
year (in Rs.)
 IND AS 23: BORROWING COST 97

Particulars Phase I Phase II Phase III Phase IV

Cash expenditure 20,00,000 35,00,000 25,00,000 40,00,000
Plant purchased 28,00,000 40,00,000 30,00,000 48,00,000
Total Expenditure 48,00,000 75,00,000 55,00,000 88,00,000
Total Exp. of all Phases 2,66,00,000
Loan Taken at 16% 2,40,00,000

During the current year, Phases I and II have become operational. Find out the total
amount to be capitalized and to be expensed during the year.

SOLUTION

S.No. Particulars Amount Rs.

1. Interest Expense on Loan (Assuming that Loan is taken on 38,40,000
the first day of the financial period concerned, and the work
of asset creation had started on that date) = Rs. 2,40,00,000
at 16%
2. Total Cost of Phases I and II (Rs. 48,00,000 + Rs. 75,00,000) 1,23,00,000
3. Total Cost of Phases III and IV (Rs. 55,00,000 + Rs.88,00,000) 1,43,00,000
4. Total Cost of all 4 Phases 2,66,00,000
5. Total Loan 2,40,00,000
6. Proportionate Loan used for Phases I and II
2,40,00,000 1,10,97,744
   x 1,23,00,000
2.66.00,000

7. Proportionate Loan used for Phases IIII and IV

2,40,00,000 1,29,02,256
   x 1,43,00,000
2.66.00,000

8. Interest on Loan used for Phases I & II, based on 17,75,639

Proportionate Loan Amount = 1,10,97,744 at 16%
9. Interest on Loan used for Phases III & IV based on 20,64,361
Proportionate Loan Amount = 1,29,02,256 x 16%

Accounting Treatment: Interest of Rs. 17,75,639 relating to Phases I and II should be

expensed (in the ratio of Asset Costs 48:75), and not to be added to respective Assets
in Phases I and II. Interest of Rs. 20,64,361 relating to Phases III and IV should be
 98 IND AS 23: BORROWING COST

held in Capital work in Progress till asset construction work is completed, and thereafter
capitalized in the ratio of cost of assets.

  QUESTION NO 23

The Notes to Accounts of Gopal Ltd. for the year ended 31st March includes the following –
“Interest on Bridge Loan from Banks and Financial Institutions and on Debentures
specifically obtained for the Company’s Fertilizer Project amounting to Rs. 1,80,80,000 has
been capitalized during the year, which includes approximately Rs. 1,70,33,465 capitalised
in respect of the utilization of Loan and Debenture Money for the said purpose” is the
treatment correct? Briefly comment.

SOLUTION
The given case is one of Specific Borrowings for Fertilizer Project and hence the capitalized
Borrowing Cost should be restricted to the actual amount of interest expenditure i.e. Rs.
1,70,33,465. Capitalisation of Rs. 180,80,000 has been resulted in over-statement of profits
and assets by Rs. 10,46,535.

  QUESTION NO 24 (SIMILAR AS QUESTION 17)

Guha Limited borrowed an amount of Rs. 150 Crores on 1st April, for construction of Boiler
Plant at 11% p.a. The Plant is expected to be completed in 4 years. The Weighted Average
Cost of Capital is 13% p.a. The Accountant of Guha Ltd. capitalized interest of Rs. 19.50
Crores for the accounting period ending on 31st March. Due to Surplus Funds out of Rs. 150
Crores, an income Rs. 3.50Crores was earned and credited to P&L A/c. comment.

SOLUTION

1. Capitalization based on the Weighted Average Cost of Capital 13% is not proper in the
above case, since the above is a case of Specific Borrowings.
2. Income received on Temporary Investments should be reduced from the Borrowing
Cost and should not be credited to Profit & Loss A/c. The correct treatment is as
under:-

Actual Interest Cost = Rs. 150 Crores x 11% Rs. 16.50 Crores
Less: Income from Temporary Investments Rs. 3.50 Crores
Borrowing Costs to be Capitalised under IND AS-23 Rs. 13.00 Crores
 IND AS 23: BORROWING COST 99

  QUESTION NO 25

Parasuram Ltd. had the following borrowings during a year in respect of capital expansion.

Plant Cost of Asset Remarks

Plant P Rs. 100 Lakhs No Specific Borrowings.
Plant Q Rs. 125 Lakhs Bank Loan of Rs. 65 Lakhs at 10%.
Plant R Rs. 175 Lakhs 9% Debentures of Rs. 125 Lakhs were issued

In addition to the above specific borrowings, the Company had obtained Term Loans from
two Banks – (1) Rs. 100 Lakhs at 10% from Corporation Bank and (2) Rs. 110 Lakhs at 11.50%
from Canara Bank, to meet its capital expansion requirements. What is the amount of
Borrowing Costs to be capitalized in each of the above Plants ?

SOLUTION

1. Computation of Actual Borrowing Costs incurred during the year:

Source Loan Amount Interest Rate Interest Amount

Bank Loan Rs. 65.00 Lakhs 10.00% Rs. 6.50 Lakhs
9% Debentures Rs.125.00 Lakhs 9.00% Rs. 11.25 Lakhs
Term Loan from Rs. 100.00 Lakhs 10.00% Rs. 10.00 Lakhs
Corporation Bank
Term Loan from Canara Rs. 110.00 Lakhs 11.50% Rs. 12.65 Lakhs
Bank
Total Rs. 400.00 Lakhs Rs. 40.40 Lakhs
Specific Borrowings Rs. 190.00 Lakhs Rs. 17.75 Lakhs
included in above

2. Weighted Average Capitalisation Rate for General Borrowings =

Total Interest Less Interest on Specific Borrowings

Total Borrowings Less Specific Borrowings

40.40 - 17.75
=
400 - 190

22.65
= = 10.79%
210
100 IND AS 23: BORROWING COST

3. Capitalisation of Borrowing Costs under IND AS-23 will be as under:-

Plant Borrowing Loan Amount Interest Interest Cost of Asset

Rate Amount
P General Rs. 100 Lakhs 10.79% Rs. 10.79 Lakhs Rs. 110.79 Lakhs
Q Specific Rs. 65 Lakhs 10.00% Rs. 6.50 Rs.137.97 Lakhs
General Rs. 60 Lakhs 10.79% Rs. 6.47 Lakhs
R Specific Rs. 125 Lakhs 9.00% Rs.11.25 Rs. 191.64 Lakhs
General Rs. 50 Lakhs 10.79% Rs. 5.39
Total Rs. 400 Lakhs Rs. 40.40 Lakhs

Note: The amount of Borrowing Costs capitalized should not exceed the actual interest
cost.

  QUESTION NO 26 (SAME AS QUESTION 7)

Madhav Limited began construction of a New Plant on 1st April 2013 and obtained a special
Loan of Rs. 8 Lakhs at 10% p.a. to finance the construction of the Plant. The expenditure
that was made on the project of Plant construction was as -
On 01.04.2014 Rs. 10,00,000
On 01.08.2014 Rs. 24,00,000
On 01.01.2014 Rs.4,00,000
The Company’s other outstanding Non-Specific Loan was Rs. 46,00,000 at an interest of
12% p.a. The construction of Plant was completed on 31.03.2014. Compute the amount of
interest to be capitalized.

SOLUTION
Computation of Interest Amount to be capitalized

Date Amount Spent (Rs.) Computation Interest

Amount (Rs)
01.04.2013 10,00,000 Rs. 8,00,000 from Specific 80,000
Loan = Rs. 8,00,000 x 10%

Rs. 2,00,000 from Non Specific 24,000

Loan = Rs.2,00,000 x 12%
 IND AS 23: BORROWING COST 101

01.08.2013 24,00,000 From Non Specific Loan 1,92,000

Rs. 2400,000 x 12% x 8/12
01.01.2014 4,00,000 From Non Specific Loan 12,000
Rs. 4,00,000 x 12% x 3/12
Total 38,00,000 3,08,000

Total Amount Capitalized = Cost Incurred Rs. 38,00,000 + Interest capitalized under
IND AS-23 Rs. 308,000 = Rs. 41,08,000.

  QUESTION NO 27 (PARA 6 E ON EXCHANGE DIFFERENCE)

Harkishan Ltd. took a loan of USD 20,000 at6% p.a. on 1st April for a specific capital
expansion project. The interest was payable annually. The Exchange Rate at the date of
the loan was 1 USD = Rs. 52.00. However, the Company could have taken a corresponding
Rupee Loan from Banks at 12% p.a. on that date. At the end of the year, the Exchange Rate
was 1 USD = Rs. 55.00 How will you treat the Borrowing Costs and Exchange Differences in
the above case?
Analyse the impact of the following changes independently. What would be the accounting
treatment if the Rupees Loan were to carry interest at 14% p.a.? What will be the treatment
if the Exchange Rate at the year end was 1 USD = Rs.53.00?

SOLUTION

S.No. Particulars Situation 1 Situation 2 Situation 3

Interest at12% Interest at 1 USD =
14% Rs.53.00
1. Interest on Local $ 20,000 x $ 20,000 x $ 20,000 x
Currency Borrowings Rs.52 x 12% = Rs.52 x 14% = Rs.52 x 12% =
Rs.1,24,800 Rs.1,45,600 Rs.1,24,800

2. Interest on Foreign $ 20,000x6% $ 20,000 x $ 20,000 x 6%

Currency Borrowings x Rs.55 = 6% x Rs.55 = x Rs.53 = Rs.
Rs.66,000 Rs.66,000 63,600

3. Interest Difference Rs. 58,800 Rs. 79,600 Rs. 61,200

between Foreign
& Local Currency
Borrowings = (1) – (2)
102 IND AS 23: BORROWING COST

4. Exchange Difference $ 20,000 x (55- $ 20,000 x (55- $ 20,000 x (53-

in Principal repayable 52) = Rs.60,000 52) = Rs.60,000 52) = Rs. 20,000
at the end of the
year

5. Further Amt. to be Rs. 58,800 Rs. 60,000 Rs. 20,000

treated as Borrowing
Costs = (3) or (4),
whichever is less.

6. Exchange Difference Rs. 1,200 Nil Nil

to be taken to P&L
/c. as per AS-11 = (4)
– (5)
7. Borrowing Costs Rs. 1,24,800 Rs. 1,26,000 Rs. 83,600
under
IND AS-23 = (2)+(5)

  QUESTION NO 28

Srivats Co-operative Society Ltd. has borrowed a sum of US $ 12.50 Million at the
commencement of the Financial year 2012-13 for its Solar Energy Project at LIBOR (London
Interbank Offered Rate of 1%) + 4% Interest is payable at the end of the respective
financial year. The Loan was availed at the then rate of RS. 52 to the Dollar while the
rate as on 31st March 2013, is Rs. 55 to the US Dollar. Had the Company borrowed the
Rupee equivalent in India, the interest would have been 11%. Compute. Borrowing Cost, also
showing the amount of Exchange Difference as per AS.

SOLUTION

S.No Particulars Result

1. Interest Payable if Borrowed in INR = Rs. 71.50 Million
(USD 12.50 Million x Opening Exchange Rate Rs. 52 x
INR Loan Interest Rate 11%)

2. Interest Actually Paid in Foreign Currency = Rs. 34.38 Millions

Foreign Currency Loan USD 12.50 Million x
Closing Exchange Rate Rs. 55 x USD Interest Rate 5%
 IND AS 23: BORROWING COST 103

3. Notional Savings in Interest due to Foreign Currency Rs. 37.12 Millions

Borrowings = (1-2)

4. Change in Carrying Amount of Principal due to Exchange

Rate Difference = Rs. 37.50 Millions
(Closing Exchange Rate Rs. 55 Less Opening Exchange
Rate Rs.52) x USD 12.5 Millions
Note: Since Closing Rate > Opening Rate, there is an
Increase in Carrying Amount in this case.

5. Further Amount to be treated as Borrowing Cost = Rs. 37.12 Millions

Least of (3) and (4)

6. Aggregate Borrowing Cost as per IND AS-23 = Actual Rs. 71.50 Millions
Interest as per (2) + Additional in (5)

7. Exchange Rate Less to be Recognized in Statement of Rs .38 Millions

P&L = (4-5)

  QUESTION NO 29

Kaladhar Ltd. dealing in timber finds it advantageous to store selected grades of timber for
a prolonged period in order to improve their quality. It desires to include an actual interest
cost of holding the timber as part of the value of unsold timber in inventory, and consult
you in order to determine whether in your opinion, such a method of valuation would be fair
and reasonable and in accordance with generally accepted accounting principles. Give your
opinion with reasons.
Would your answer be different if the Company did not actually incur any interest charges
for holding the timber but desired to include notional interest charges which could be
imputed to the Company’s own Paid-up Capital and Reserves which are invested in holding
the timber for maturity?
(HINT: IND AS 23 IS NOT APPLICABLE FOR BIOLOGICAL ASSETS)

  QUESTION NO 30 (DATE WISE CAPITALISATION) (CLASS EXAMPLE)

Assume NDA Limited begins construction on a new building on 1st January, 2004. In addition,
NDA Limited obtained a Rs. 1 Lakh loan to finance the construction of the building on 1st
January, 2004 at an annual interest rate of 10%. The company’s other outstanding debt
during 2004 consists of two loans of Rs. 6 Lakhs and Rs. 8 Lakhs with interest rates of
11% and 13% respectively. Expenditures that were made on the building project were as
follows:
 104 IND AS 23: BORROWING COST

January 2004 200000

April 2004 300000
July 2004 400000
December 2004 120000
Compute the cost to be capitalized including borrowing cost

SOLUTION
STEP 1:
Computation of average accumulated expenses
Rs. 200,000 x 12/12 (January – December) = Rs. 200,000
Rs. 300,000 x 9/12 (April – December) = Rs. 225,000
Rs. 400,000 x 6/12 (July-December) = Rs. 200,000
Rs. 120,000 x 1/12 (December) = Rs. 10,000
Rs. 1020,000 Average Accumulated Expenses = Rs. 635,000

STEP 2
Compute the average interest rate based on the other outstanding debt of the entity
other than specific borrowings:

600,000 x 11% = Rs. 66,000

800,000 x 13% = Rs. 104,000
1,400,000 Rs. 170,000

Average interest rate : Rs. 170,000/1,400,000 = 12.14%

STEP 3
Compute the interest on average accumulated expenses

Average Accumulated Expenses (AAE) Interest to be capitalized

(based on AAE)
100,000 (Specific borrowings) x 10% = 10,000
535,000 (635,000 – 100,000) x 12.14% 64,950
635,000 74,950
 IND AS 23: BORROWING COST 105

STEP 4
Compute actual interest costs incurred during the year.
100,000 x 10% = Rs. 10,000
600,000 x 11% = Rs. 66,000
800,000 x 13% = Rs. 104,000
Total Rs. 180,000

Amount to be capitalized is Rs. 74,950 which is not more than actual interest of Rs. 180,000
(Amt. in Rs.)
Building Account Dr. 1094950
To Cash 1094950

  QUESTION NO 31 (BIOLOGICAL ASSETS)

Dhangar Ltd. has a cattle field which serves the company milk, wool etc. The livestock is
carried at Fair value. The Opening fair value of livestock is Rs. 54,40,000. The closing fair
value Rs.67,33,000. Out of which Rs. 2,00,000 worth was purchased during the year. Fresh
borrowings were taken at the beginning of the year to buy livestock. The total borrowings
by the year end was Rs. 22,00,000 @ 12%. Calculate the borrowing cost as per Ind AS-23
and comment.

SOLUTION
Ind AS-23 is not applicable on Biological Assets. It is applicable on those assets which are
carried at cost less depreciation. Also further the assets should be qualifying assets. In
the present case the entire BC of Rs. 2,64,000 is charged to profit/loss account. BC should
not be capitalized on biological assets.

  QUESTION NO 32 (HYPER INFLATIONARY SITUATION) ( IND AS 29)

Hyper Ltd is engaged in development of properties and further sell it in the open market.
The development process takes substantial period of time. It has financed its inventories
by taking loan from Yekoshore Development Bank £ 75 million. The economy is under hyper
inflationary situation. The interest rate is 32%. The inflation is 200%. You are required
to calculate the borrowing cost attributable towards the capitalization of asset as per Ind
As 23

SOLUTION
Ind AS-23 : In case of Hyperinflationary situation the borrowing costs relate to the
inflationary element is charged to income statement and not to be capitalized.
 106 IND AS 23: BORROWING COST

Accordingly the effective (real element of) interest = 32% / 200% - 16%.
BC requires capitalization = 75 x 16% = £ 12 million.
BC charged to P/L = 75 x 32% - 12 = £ 12 million.

  QUESTION NO 33: DATE OF COMMENCEMENT

X Ltd is commencing a new construction project, which is to be financed by borrowing. The

key dates are as follows:

(i) 15 May 20X1: Loan interest relating to the project starts to be incurred
(ii) 2 June 20X1 : Technical site planning commences
(iii) 19 June 20X1 : Expenditure on the project started to be incurred
(iv) 18 July 20X1 : Construction work commences

Identify commencement date.

SOLUTION
In the above case, the three conditions to be tested for commencement date would be:
Borrowing cost has been incurred on: 15 May 20X1
Expenditure has been incurred for the asset on: 19 June 20X1
Activities necessary to prepare asset for its intended use or sale: 2 June 20X1
Commencement date would be the date when the above three conditions would be satisfied
in all i.e 19 June 20X1.

  QUESTION NO 34 (PARA 6 E EXCHAGE DIFFERENCES)

ABC Ltd. has taken a loan of USD 20,000 on April 1, 20X1 for constructing a plant at an
interest rate of 5% per annum payable on annual basis.
On April 1, 20X1, the exchange rate between the currencies i.e USD Vs INR was ` 45 per
USD. The exchange rate on the reporting date i.e March 31, 20X2 is ` 48 per USD.
The corresponding amount could have been borrowed by ABC Ltd from State bank of India
in local currency at an interest rate of 11% per annum as on April 1, 20X1.
Compute the borrowing cost to be capitalized for the construction of plant by ABC Ltd.

SOLUTION

In the above situation, the Borrowing cost needs to determine for interest cost on such
foreign currency loan and eligible exchange loss difference if any.
 IND AS 23: BORROWING COST 107

(a) Interest on Foreign currency loan for the period : USD 20,000 x 5% = USD 1,000
Converted in ` : USD 1,000 x ` 48/USD = ` 48,000
Increase in liability due to change in exchange difference :

USD 20,000 x (48 - 45) = ` 60,000

(b) Interest that would have resulted if the loan was taken in Indian Currency:

USD 20,000 x ` 45/USD x 11% = ` 99,000

(c) Difference between Interest on Foreign Currency borrowing and local Currency
borrowing : ` 99,000 - 48,000 = ` 51,000
Hence, out of Exchange loss of ` 60,000 on principal amount of foreign currency loan, only
exchange loss to the extent of ` 51,000 is considered as borrowing costs.
Total borrowing cost to be capitalized is as under :

(a) Interest cost on borrowing ` 48,000

(b) Exchange difference to the extent considered to be an adjustment to ` 51,000
Interest cost
` 99,000

The exchange difference of ` 51,000 has been capitalized as borrowing cost and the
remaining ` 9,000 will be expensed off in the Statement of Profit and loss.

  QUESTION NO 35 CAPITALISATION RATE

Beta Ltd had the following loans in place at the end of 31st March 20X2
(Amounts in ` 000s)

Loan 1st April 20X1 31st March 20X2

18% Bank Loan 1,000 1,000
16% Term Loan 3,000 3,000
14% Debentures 2,000

14% debenture was issued to fund the construction of Office building on 1st July 20X1 but
the development activities has yet to be started.
On 1st April 20X1, Beta ltd began the construction of a Plant being qualifying asset using
the existing borrowings. Expenditure drawn down for the construction was: ` 500,000 on
1st April 20X1 and ` 2,500,000 on 1st January 20X2.
108 IND AS 23: BORROWING COST

Required
Calculate the borrowing cost that can be capitalised for the plant.

SOLUTION

(18% x 1,000) (16% x 3,000)

Capitalisation rate + 16.5%
1,000 + 3,000 1,000 +3,000

Borrowing Costs (500,000 x 16.5%) + (2,500,000 x 16.5% x 3/12) ` 1,85,625

 IND AS 23: BORROWING COST 109

PAST EXAMINATION QUESTIONS

QUESTION 1 NOVEMBER 2019 EXAM

An entity constructs a new office building commencing on 1st September, 2018, which
continues till 31st December, 2018 (and is expected to go beyond a year).Directly
attributable expenditure at the beginning of the month on this asset are ` 2 lakh in
September 2018 and ` 4 lakh in each of the months of October to December 2018.
The entity has not taken any specific borrowings to finance the construction of the building but
has incurred finance costs on its general borrowings during the construction period. During the
year, the entity had issued 9% debentures with a face value of ` 30 lakh and had an overdraft
of ` 4 lakh, which increased to ` 8 lakh in December 2018. Interest was paid on the overdraft
at 12% until 1st October, 2018 and then the rate was increased to 15%.
Calculate the capitalization rate for computation of borrowing cost in accordance with
Ind AS ‘Borrowing Cost’.

ANSWER
Calculation of capitalization rate on borrowings other than specific borrowings

Nature of Period of Amount of loan Rate of Weighted average amount

general borrow- outstanding i n t e r e s t of interest
ings (`) p.a.
balance (`)
a b c d = [(b x c) x (a/12)]
9% Debentures 12 months 30,00,000 9% 2,70,000
Bank overdraft 9 months 4,00,000 12% 36,000
2 months 4,00,000 15% 10,000
1 month 8,00,000 15% 10,000
46,00,000 3,26,000
Weighted average cost of borrowings
= {30,00,000 x(12/12)} + {4,00,000 x (11/12)} + {8,00,000 x (1/12) = 34,33,334

Capitalisation rate = (Weighted average amount of interest / Weighted average of gen-

eral borrowings) x 100

= (3,26,000 / 34,33,334) x 100 = 9.50% p.a.

110 IND AS 23: BORROWING COST

NOTES
 IND AS-36: IMPAIRMENT OF ASSETS 111

IND AS-36: IMPAIRMENT OF ASSETS

  QUESTION 1

The carrying value of a building in the books of Sun Ltd. as at Mar 31, 20X1 is ` 300 lakhs.
As on that date the value in use is ` 250 lakhs and fair value less cost of disposal is ` 238
lakhs. Calculate the Recoverable Amount.

SOLUTION
Recoverable Amount: Higher of Fair Value less Costs of disposal and Value in Use Fair Value
less costs of disposal: ` 250 Lakhs
Value in Use: ` 238 Lakhs
Therefore, Recoverable value will be ` 250 lakhs

  QUESTION 2

Saturn India Ltd is reviewing one of its business segments for impairment. The carrying
value of its net assets is 40 million. Management has produced two computations for the
value -in-use of the business segment. The first value of ` 36 million excludes the benefit
to be derived from a future reorganization, but the second value of ` 44 million includes
the benefits to be derived from the future reorganization. There is not an active market
for the sale of the business segments.
Whether the business segment needs to be Impaired?

SOLUTION
The benefit of the future reorganization should not be taken into account in calculating
value-in-use. Therefore, the net assets of the business segment will be impaired by ` 4
million because the value-in- use of ` 36 million is lower than the carrying value of ` 40
million. The value-in-use can be used as the recoverable amount as there is no active market
for the sale of the business segment.

QUESTION 3

Mars Ltd. gives the following estimates of cash flows relating to property, plant and
equipment on 31-03-20X4. The discount rate is 15%

Year Cash flow (INR Lakhs)

20X4-20X5 2,000
20X5-20X6 3,000
20X6-20X7 3,000
 112 IND AS-36: IMPAIRMENT OF ASSETS

20X7-20X8 4,000
20X8-20X9 2,000
Residual Value at 31.03.20X9 500

Property, Plant & equipment was purchased on 1.04.20X1 for ` 20,000 lakhs
Useful life was 8 years
Residual value estimated at the end of 8 years ` 500 lakhs
Fair value less cost to disposal ` 10,000 lakhs

  QUESTION 4: IMPAIRMENT LOSS

Jupiter Ltd, a leading manufacturer of steel is having a furnace, which is carried in the
balance sheet on 31.03.20X1 at ` 250 lakhs. As at that date the value in use and Fair value
is ` 200 lakhs. The cost of disposal is ` 13 lakhs.
Calculate the Impairment Loss to be recognised in the books of the Company?

SOLUTION
Calculation of Impairment Loss:

Calculation of Impairment Loss INR in Lakhs

Recoverable Amount = 200
Higher of, Fair Value less Cost of Disposal ( 200-13) 187
Or
Value in Use 200
Impairment Loss = Carrying Amount – Recoverable Amount = 250-200 50

  QUESTION 5 (WE WILL COVER IT IN IND AS 12)

Mercury ltd has an identifiable asset with a carrying amount of ` 1,000. Its recoverable
amount is ` 650. The tax rate is 30% and the tax base of the asset is ` 800. Impairment
losses are not deductible for tax purposes. The effect of the impairment loss is as follows:
 IND AS-36: IMPAIRMENT OF ASSETS 113

SOLUTION:

Identifiable Impairment Identifiable

assets before loss assets after
impairment loss impairment loss
` ` `
Carrying amount 1,000 (350) 650
Tax base 800 - 800
Taxable (deductible 200 (350) (150)
temporary
Deferred tax liability 60 (105) (45)
(asset) at 30%

In accordance with Ind AS 12, the entity recognises the deferred tax asset to the extent
that it is probable that taxable profit will be available against which the deductible
temporary difference can be utilised.

  QUESTION 6

A mining entity owns a private railway to support its mining activities. The private railway
could be sold only for scrap value and it does not generate cash inflows that are largely
independent of the cash inflows from the other assets of the mine.

SOLUTION:
It is not possible to estimate the recoverable amount of the private railway because its
value in use cannot be determined and is probably different from scrap value. Therefore,
the entity estimates the recoverable amount of the cash-generating unit to which the
private railway belongs, ie the mine as a whole

  QUESTION 7

A bus company provides services under contract with a municipality that requires minimum
service on each of five separate routes. Assets devoted to each route and the cash flows
from each route can be identified separately. One of the routes operates at a significant
loss.

SOLUTION:
Since the entity does not have the option to curtail any one bus route, the lowest level of
identifiable cash inflows that are largely independent of the cash inflows from other assets
or groups of assets is the cash inflows generated by the five routes together. The cash-
generating unit for each route is the bus company as a whole.
 114 IND AS-36: IMPAIRMENT OF ASSETS

  QUESTION 8

A company operates a mine in a country where legislation requires that the owner must
restore the site on completion of its mining operations. The cost of restoration includes
the replacement of the overburden, which must be removed before mining operations
commence. A provision for the costs to replace the overburden was recognised as soon
as the overburden was removed. The amount provided was recognised as part of the cost
of the mine and is being depreciated over the mine’s useful life. The carrying amount of
the provision for restoration costs is ` 500, which is equal to the present value of the
restoration costs.
The entity is testing the mine for impairment. The cash-generating unit for the mine is the
mine as a whole. The entity has received various offers to buy the mine at a price of around
` 800. This price reflects the fact that the buyer will assume the obligation to restore
the overburden. Disposal costs for the mine are negligible. The value in use of the mine is
approximately ` 1,200, excluding restoration costs. The carrying amount of the mine is `
1,000.

SOLUTION:
The cash-generating unit’s fair value less costs of disposal is ` 800. This amount considers
restoration costs that have already been provided for. As a consequence, the value in use
for the cash-generating unit is determined after consideration of the restoration costs and
is estimated to be ` 700 (` 1,200 less ` 500). The carrying amount of the cash-generating
unit is ` 500, which is the carrying amount of the mine (` 1,000) less the carrying amount
of the provision for restoration costs (` 500). Therefore, the recoverable amount of the
cash-generating unit exceeds its carrying amount.
For practical reasons, the recoverable amount of a cash-generating unit is sometimes
determined after consideration of assets that are not part of the cash-generating unit (for
example, receivables or other financial assets) or liabilities that have been recognised (for
example, payables, pensions and other provisions). In such cases, the carrying amount of
the cash-generating unit is increased by the carrying amount of those assets and decreased
by the carrying amount of those liabilities.

  QUESTION 9

An entity sells for ` 100 an operation that was part of a cash-generating unit to which
goodwill has been allocated. The goodwill allocated to the unit cannot be identified or
associated with an asset group at a level lower than that unit, except arbitrarily. The
recoverable amount of the portion of the cash-generating unit retained is ` 300.

SOLUTION
Since the goodwill allocated to the cash- generating unit cannot be non-arbitrarily identified
 IND AS-36: IMPAIRMENT OF ASSETS 115

or associated with an asset group at a level lower than that unit, the goodwill associated
with the operation disposed of is measured on the basis of the relative values of the
operation disposed of and the portion of the unit retained. Therefore, 25 per cent of the
goodwill allocated to the cash-generating unit is included in the carrying amount of the
operation that is sold.
If an entity reorganises its reporting structure in a way that changes the composition of
one or more cash -generating units to which goodwill has been allocated, the goodwill shall
be reallocated to the units affected. This reallocation is performed by using a relative
value approach similar to that used when an entity disposes of an operation within a cash-
generating unit, unless the entity can demonstrate that some other method better reflects
the goodwill associated with the reorganised units.

  QUESTION 10

Goodwill had previously been allocated to cash -generating unit A. The goodwill allocated
to A cannot be identified or associated with an asset group at a level lower than A, except
arbitrarily. A is to be divided and integrated into three other cash-generating units, B, C
and D.

SOLUTION
Since the goodwill allocated to A cannot be non -arbitrarily identified or associated with an
asset group at a level lower than A, it is reallocated to units B, C and D on the basis of the
relative values of the three portions of A before those portions are integrated with B, C
and D.

  QUESTION 11 (CORPORATE ASSETS)

Earth Infra Ltd has two cash- generating units, X and Y. There is no goodwill within the
units’ carrying values. The carrying values of the CGUs are CGU A for ` 20 million and CGU B
for ` 30 million. The company has an office building which it is using as a office headquarter
has not been included in the above values and can be allocated to the units on the basis of
their carrying values. The office building has a carrying value of ` 10 million. The recoverable
amounts are based on value-in-use of ` 18 million for CGU A and ` 38 million for CGU B.
Required: Determine whether the carrying values of CGU A and B are impaired.

  QUESTION 12

A machine has suffered physical damage but is still working, although not as well as before
it was damaged. The machine’s fair value less costs of disposal is less than its carrying
amount. The machine does not generate independent cash inflows. The smallest identifiable
group of assets that includes the machine and generates cash inflows that are largely
independent of the cash inflows from other assets is the production line to which the
 116 IND AS-36: IMPAIRMENT OF ASSETS

machine belongs. The recoverable amount of the production line shows that the production
line taken as a whole is not impaired.
Assumption 1: budgets/ forecasts approved by management reflect no commitment
management to replace the machine.
Assumption 2: budgets/ forecasts approved by management reflect a commitment
management to replace the machine and sell it in the near future. Cash flows from continuing
use of the machine until its disposal are estimated to be negligible.

SOLUTION:

1. The recoverable amount of the machine alone cannot be estimated because the
machine’s value in use:
a) may differ from its fair value less costs of disposal; and
b) can be determined only for the cash-generating unit to which the machine belongs
(the production line).
The production line is not impaired. Therefore, no impairment loss is recognised for
the machine. Nevertheless, the entity may need to reassess the depreciation period
or the depreciation method for the machine. Perhaps a shorter depreciation period
or a faster depreciation method is required to reflect the expected remaining useful
life of the machine or the pattern in which economic benefits are expected to be
consumed by the entity.
2. The machine’s value in use can be estimated to be close to its fair value less costs of
disposal. Therefore, the recoverable amount of the machine can be determined and no
consideration is given to the cash-generating unit to which the machine belongs (i.e.
the production line). Because the machine’s fair value less costs of disposal is less than
its carrying amount, an impairment loss is recognised for the machine.
After the allocation procedures have been applied, a liability is recognised for any remaining
amount of an impairment loss for a cash-generating unit if, and only if, that is required by
another Indian Accounting Standard.

  QUESTION 13: REVERSAL OF IMPAIRMENT LOSS

On 1st April 20X1, Venus ltd acquired 100% of Saturn ltd for ` 4,00,000. The fair value of
the net identifiable assets of Saturn ltd was ` 3,20,000 and goodwill was ` 80,000. Saturn
ltd is in coal mining business. On 31st March 20X3 the government has cancelled licenses
given to it in few states.
As a result Saturn’s ltd revenue is estimated to get reduce by 30%. The adverse change
in market place and regulatory conditions is an indicator of impairment. As a result, Venus
ltd has to estimate the recoverable amount of goodwill and net assets of Saturn ltd on
 IND AS-36: IMPAIRMENT OF ASSETS 117

31st March 20X3. Venus ltd uses straight line depreciation. The useful life of Saturn’s ltd
assets is estimated to be 20 years with no residual value. No independent cash inflows can
be identified to any individual assets. So the entire operation of Saturn ltd is to be treated
as a CGU. Due to the regulatory entangle it is not possible to determine the selling price of
Saturn ltd as a CGU. Its value in use is estimated by the management at ` 2,12,000.
Suppose by 31st March 20X5 the government reinstates the licenses of Saturn ltd. The
management expects a favourable change in net cash flows. This is an indicator that an
impairment loss may have reversed. The recoverable amount of Saturn’s ltd net asset is re-
estimated. The value in use is expected to be ` 3,04,000 and net selling price is expected
to be ` 2,90,000.

  QUESTION 14:

From the following details of an asset, find out:

(a) Impairment loss and its treatment.

(b) Current year depreciation at the year end.

Particulars of assets:

Cost of asset ` 56 lakhs

Useful life 10 years
Salvage value Nil
Carrying value at the beginning of the year ` 27.30 lakhs
Remaining useful life 3 years
Recoverable amount at the beginning of the year ` 12 lakhs
Upward revaluation done in last year ` 14 lakhs

  QUESTION 15

Venus Ltd. has an asset, which is carried in the Balance Sheet on March 31, 20X1 at ` 500
lakhs. As at that date the value in use is ` 400 lakhs and the fair value less costs to sells
is ` 375 lakhs.
From the above data:

(a) Calculate impairment loss.

(b) Prepare journal entries for adjustment of impairment loss.
(c) Show, how impairment loss will be shown in the Balance Sheet.
 118 IND AS-36: IMPAIRMENT OF ASSETS

SOLUTION
According to Ind AS 36, Impairment of Assets, impairment loss is the excess of ‘Carrying
amount of the asset’ over ‘Recoverable Amount’.
In the present case, the impairment loss can be computed in the following manner:
Step 1: Fair value less costs to sell: ` 375 lakhs
Step 2: Value in use: ` 400 lakhs
Step 3: Recoverable amount, i.e., higher of ‘fair value less costs to sell’ & ‘value in use’.
Thus, recoverable amount is ` 400 lakhs
Step 4: Carrying amount of the asset ` 500 lakhs
Step 5: Impairment loss, i.e., excess of amount computed in step 4 over amount
computed in Step 3. ` 100 lakhs (being the difference between ` 500 lakhs
and ` 400 lakhs).
According to Ind AS 36, an impairment loss should be recognised as an expense in the
statement of profit and loss immediately, unless the asset is carried at revalued amount in
accordance with another Accounting Standard. Assuming, that the asset is not carried at
revalued amount, the impairment loss of ` 100 lakhs will be charged to Profit & Loss Account.
Journal Entries

Date Particulars Dr. Cr.

Amt. Amt.
` in Lakhs
31.3.20X1 Impairment Loss A/c Dr. 100
To Assets A/c 100
Being impairment loss on an asset
recognised)
31.3.20X1 Statement of Profit & Loss Dr. 100
To Impairment Loss A/c 100
(Being impairment loss transferred to
statement of profit and loss)

  QUESTION 16

A publisher owns 150 magazine titles of which 70 were purchased and 80 were self-created.
The price paid for a purchased magazine title is recognised as an intangible asset. The costs
of creating magazine titles and maintaining the existing titles are recognised as an expense
when incurred. Cash inflows from direct sales and advertising are identifiable for each
 IND AS-36: IMPAIRMENT OF ASSETS 119

magazine title. Titles are managed by customer segments. The level of advertising income
for a magazine title depends on the range of titles in the customer segment to which the
magazine title relates. Management has a policy to abandon old titles before the end of
their economic lives and replace them immediately with new titles for the same customer
segment. What is the cash-generating unit for an individual magazine title?

SOLUTION
It is likely that the recoverable amount of an individual magazine title can be assessed.
Even though the level of advertising income for a title is influenced, to a certain extent, by
the other titles in the customer segment, cash inflows from direct sales and advertising are
identifiable for each title. In addition, although titles are managed by customer segments,
decisions to abandon titles are made on an individual title basis. Therefore, it is likely that
individual magazine titles generate cash inflows that are largely independent of each other
and that each magazine title is a separate cash-generating unit.

  QUESTION 17

A mining entity owns a private railway to support its mining activities. The private railway
could be sold only for scrap value and it does not generate cash inflows that are largely
independent of the cash inflows from the other assets of the mine. Should the entity
determine the recoverable amount for the private railway or for the mining business as a
whole?

SOLUTION
It is not possible to estimate the recoverable amount of the private railway because its
value in use cannot be determined and is probably different from scrap value. Therefore,
the entity estimates the recoverable amount of the cash-generating unit to which the
private railway belongs, i.e., the mine as a whole.

  QUESTION 18

A bus company provides services under contract with a municipality that requires minimum
service on each of seven separate routes. Assets devoted to each route and the cash flows
from each route can be identified separately. One of the routes operates at a significant
loss. Should the company determine the recoverable amount for an individual asset or for
a cash generating unit?

SOLUTION
Because the entity does not have the option to curtail any one bus route, the lowest level of
identifiable cash inflows that are largely independent of the cash inflows from other assets
or groups of assets is the cash inflows generated by the seven routes together. The cash-
generating unit for each route is the bus company as a whole.
 120 IND AS-36: IMPAIRMENT OF ASSETS

  QUESTION 19 (INTER DEPTT. SALE: UNIT 3 IN CLASS NOTES)

A significant raw material used for plant Y’s final production is an intermediate product
bought from plant X of the same entity. X’s products are sold to Y at a transfer price that
passes all margins to X. 80% of Y’s final production is sold to customers outside of the
entity.
60% of X’s final production is sold to Y and the remaining 40% is sold to customers outside
of the entity. For each of the following cases, what are the cash-generating units for X and
Y?

(a) If X could sell the products it sells to Y in an active market and internal transfer
prices are higher than market prices, what are the cash-generating units for X and Y?
(b) If there is no active market for the products X sells to Y, what are the cash-generating
units for X and Y?

SOLUTION:

(a) Cash-generating unit for X: X could sell its products in an active market and, so,
generate cash inflows that would be largely independent of the cash inflows from Y.
Therefore, it is likely that X is a separate cash-generating unit, although part of its
production is used by Y.
Cash-generating unit for Y: It is likely that Y is also a separate cash-generating unit.
Y sells 80% of its products to customers outside of the entity. Therefore, its cash
inflows can be regarded as largely independent.
Effect of internal transfer pricing: Internal transfer prices do not reflect market
prices for X’s output. Therefore, in determining value in use of both X and Y, the
entity adjusts financial budgets/forecasts to reflect management’s best estimate of
future prices that could be achieved in arm’s length transactions for those of X’s
products that are used internally.
(b) Cash-generating units for X and Y: It is likely that the recoverable amount of each
plant cannot be assessed independently of the recoverable amount of the other plant
because:
(i) the majority of X’s production is used internally and could not be sold in an active
market. So, cash inflows of X depend on demand for Y’s products. Therefore, X
cannot be considered to generate cash inflows that are largely independent of
those of Y.
(ii) the two plants are managed together.
As a consequence, it is likely that X and Y together are the smallest group of assets
that generates cash inflows that are largely independent.
 IND AS-36: IMPAIRMENT OF ASSETS 121

  QUESTION 20

XYZ Limited produces a single product and owns plants 1, 2 and 3. Each plant is located in a
different country. Plant 1 produces a component that is assembled in either Plant 2 or Plant
3. The combined capacity of Plant 2 and Plant 3 is not fully utilised. XYZ Limited’s products
are sold worldwide from either Plant 2 or Plant 3, e.g., Plant 2’s production can be sold in
Plant 3’s country if the products can be delivered faster from Plant 2 than from Plant 3.
Utilisation levels of Plant 2 and Plant 3 depend on the allocation of sales between the two
sites. If there is no active market for Plant 1’s products, what are the cash-generating
units for Plant 1, Plant 2 and Plant 3?

SOLUTION:
It is likely that the recoverable amount of each plant cannot be assessed independently
because:

(a) There is no active market for Plant 1’s products. Therefore, Plant 1’s cash inflows
depend on sales of the final product by Plant 2 and Plant 3.
(b) Although there is an active market for the products assembled by Plant 2 and Plant
3, cash inflows for Plant 2 and Plant 3 depend on the allocation of production across
the two sites. It is unlikely that the future cash inflows for Plant 2 and Plant 3 can be
determined individually.
As a consequence, it is likely that Plant 1, Plant 2 and Plant 3 together (i.e., XYZ Limited as
a whole) are the smallest identifiable group of assets that generates cash inflows that are
largely independent.

  QUESTION 21

An entity sells for ` 100 crores an operation that was part of a cash- generating unit to
which goodwill has been allocated. The goodwill allocated to the unit cannot be identified
or associated with an asset group at a level lower than that unit, except arbitrarily. The
recoverable amount of the portion of the cash-generating unit retained is ` 300 crores.
How the goodwill should be allocated to the operation sold?

SOLUTION:
Since goodwill allocated to the cash-generating unit cannot be non-arbitrarily identified or
associated with an asset group at a level lower than that unit, the goodwill associated with
the operation disposed of is measured on the basis of the relative values of the operation
disposed of and the portion of the unit retained. Therefore, 25% of the goodwill allocated
to the cash-generating unit is included in the carrying amount of the operation that is sold.
122 IND AS-36: IMPAIRMENT OF ASSETS

  QUESTION 22

Goodwill had previously been allocated to cash- generating unit A. The goodwill allocated
to A cannot be identified or associated with an asset group at a level lower than A, except
arbitrarily. A is to be divided and integrated into three other cash-generating units, B, C
and D. How the goodwill should be reallocated to B, C and D?

SOLUTION:
Since goodwill allocated to A cannot be non-arbitrarily identified or associated with an
asset group at a level lower than A, it is reallocated to units B, C and D on the basis of the
relative values of the three portions of A before those portions are integrated with B, C
and D.

  QUESTION 23

XYZ Limited has a cash-generating unit ‘Plant A’ as on April 1, 20X1 having a carrying amount
of ` 1,000 crores. Plant A was acquired under a business combination and goodwill of ` 200
crores was allocated to it. It is depreciated on straight line basis. Plant A has a useful life
of 10 years with no residual value. On March 31, 20X2, Plant A has a recoverable amount of
` 600 crores. Calculate the impairment loss on Plant A. Also, prescribe its allocation as per
Ind AS 36.

  QUESTION 24

Sun ltd is an entity with various subsidiaries. The entity closes its books of account at
every year ended on 31st March. On 1st July 20X1 Sun ltd acquired an 80% interest in Pluto
ltd. Details of the acquisition were as follows:

- Sun ltd acquired 800,000 shares in Pluto ltd by issuing two equity shares for every five
acquired The fair value of Sun Ltd’s share on 1st July 20X1 was ` 4 per share and the fair
value of a Pluto’s share was ` 1·40 per share. The costs of issue were 5% per share.
- Sun ltd incurred further legal and professional costs of ` 100,000 that directly related
to the acquisition.
- The fair values of the identifiable net assets of Pluto Ltd at 1st July 20X1 were measured
at ` 1·3 million. Sun ltd initially measured the non-controlling interest in Pluto ltd at fair value.
They used the market value of a Pluto ltd share for this purpose. No impairment of goodwill
arising on the acquisition of Pluto ltd was required at 31st March 20X2 or 20X3.
- Pluto ltd comprises three cash generating units A, B and C. When Pluto ltd was acquired the
directors of Sun ltd estimated that the goodwill arising on acquisition could reasonably
be allocated to units A: B: C on a 2:2:1 basis. The carrying values of the assets in these
cash generating units and their recoverable amounts are as follows:
 IND AS-36: IMPAIRMENT OF ASSETS 123

Unit Carrying value Recoverable amount

(before goodwill allocation)
` ’000 ` ’000
A 600 740
B 550 650
C 450 400

Required:

(i) Compute the carrying value of the goodwill arising on acquisition of Pluto Ltd in the
consolidated Balance Sheet of Sun ltd at 31st March 20X4 following the impairment
review.
(ii) Compute the total impairment loss arising as a result of the impairment review,
identifying how much of this loss would be allocated to the non-controlling interests in
Pluto ltd.
124 IND AS-36: IMPAIRMENT OF ASSETS

Extra Practical Questions

Q.1: Apex Ltd. is engaged in manufacturing of steel utensils. It owns a building for its
headquarters. The building used to be fully occupied for internal use. However, recently
the company has undertaken a massive downsizing exercise as a result of which 1/3rd
of the building became vacant. This vacant portion has now been given of on lease for 6
years. Determine the CGU of the building.

Q.2: ABC Ltd. has three cash-generating units: A, B and C, the carrying amounts of which
as on March 31, 20X1 are as follows:

(` in crores)
Cash-generating units Carrying amount Remaining useful life
A 500 10
B 750 20
C 1,100 20

ABC Ltd. also has two corporate assets having a remaining useful life of 20 years.

(` in crores)
Corporate asset Carrying amount Remarks
X 600 The carrying amount of X can be allocated on
a reasonable basis (i.e., pro rata basis) to the
individual cash-generating units.
Y 200 The carrying amount of Y cannot be allocated on a
reasonable basis to the individual cash-generating
units.

Recoverable amount as on March 31, 20X1 is as follows:

Cash-generating units Recoverable amount (` in crores)

A 600
B 900
C 1,400
ABC Ltd. 3,200

Calculate the impairment loss, if any. Ignore decimals.

 IND AS-36: IMPAIRMENT OF ASSETS 125

Q.3: A machine has suffered physical damage but is still working, although not as well
as before it was damaged. The machine’s fair value less costs to sell is less than its
carrying amount. The machine does not generate independent cash inflows. The smallest
identifiable group of assets that includes the machine and generates cash inflows that
are largely independent of the cash inflows from other assets is the production line to
which the machine belongs. The recoverable amount of the production line shows that the
production line taken as a whole is not impaired. Whether any impairment loss should be
recognised for the machine in the following cases?

(a) Budgets/forecasts approved by management reflect no commitment of management

to replace the machine.
The recoverable amount of the machine alone cannot be estimated because the
machine’s value in use:
(i) may differ from its fair value less costs to sell; and
(ii) can be determined only for the cash-generating unit to which the machine belongs
(the production line).
The production line is not impaired. Therefore, no impairment loss is recognised for
the machine. Nevertheless, the entity may need to reassess the depreciation period
or the depreciation method for the machine.
(b) Budgets/forecasts approved by management reflect a commitment of management to
replace the machine and sell it in the near future. Cash flows from continuing use of
the machine until its disposal are estimated to be negligible.

Q.4: Parent acquires an 80% ownership interest in Subsidiary for ` 2,100 on April 1,
20X1. At that date, Subsidiary’s net identifiable assets have a fair value of ` 1,500.
Parent chooses to measure the non-controlling interests as the proportionate interest of
Subsidiary’s net identifiable assets. The assets of Subsidiary together are the smallest
group of assets that generate cash inflows that are largely independent of the cash inflows
from other assets or groups of assets. Because other cash-generating units of Parent are
expected to benefit from the synergies of the combination, the goodwill of ` 500 related
to those synergies has been allocated to other cash-generating units within Parent. On
March 31, 20X2, Parent determines that the recoverable amount of cash-generating unit
Subsidiary is ` 1,000. The carrying amount of the net assets of Subsidiary, excluding
goodwill, is ` 1,350. Allocate the impairment loss on March 31, 20X2.

Q.5: A Ltd. purchased a machinery of ` 100 crores on April 1, 20X1. The machinery has
a useful life of 5 years. It has nil residual value. A Ltd. adopts straight line method of
depreciation for depreciating the machinery. Following information has been provided as
on March 31, 20X2:
126 IND AS-36: IMPAIRMENT OF ASSETS

Financial year Estimated future cash flows

(` in crores)
20X2-20X3 15
20X3-20X4 30
20X4-20X5 40
20X5-20X6 10

Discount rate applicable : 10%

Fair value less costs to sell as on March 31, 20X2 : ` 70 crores
Calculate the impairment loss, if any.

Q.6: Assuming in the above question, as on March 31, 20X3, there is no change in the
estimated future cash flows and discount rate. Fair value less costs to sell as on March
31, 20X3 is ` 40 crores. How should it be dealt with under Ind AS 36?

Financial year Estimated Cash flows Present value Present value

(` in crores) factor @ 10%
20X3-20X4 30 0.9091 27.27

20X4-20X5 40 0.8264 33.06

20X5-20X6 10 0.7513 7.51

67.84

Q.7: A Ltd. purchased an asset of ` 100 lakhs on April 1, 20X0. It has useful life of 4
years with no residual value. Recoverable amount of the asset is as follows:

As on Recoverable amount
March 31, 20X1 ` 60 lakhs
March 31, 20X2 ` 40 lakhs
March 31, 20X3 ` 28 lakhs

Calculate the amount of impairment loss or its reversal, if any, on March 31, 20X1, March
31, 20X2 and March 31, 20X3.
 IND AS-36: IMPAIRMENT OF ASSETS 127

Q.8: On March 31, 20X1, XYZ Ltd. makes following estimate of cash flows for one of its
asset located in USA:

Year Cash flows

20X1-20X2 US $ 80
20X2-20X3 US $ 100
20X3-20X4 US $ 20

Following information has been provided:

Particulars India USA

Applicable discount rate 15% 10%

Exchange rates are as follows:

As on Exchange rate
March 31, 20X1 ` 45/ US $

As on Expected Exchange rate

March 31, 20X2 ` 48/ US $
March 31, 20X3 ` 51/ US $
March 31, 20X4 ` 55/ US $

Calculate value in use as on March 31, 20X1.

Q.9: Cash flow is ` 100, ` 200 or ` 300 with probabilities of 10%, 60% and 30%, respectively.
Calculate expected cash flows.

Q.10: Cash flow of ` 1,000 may be received in one year, two years or three years with
probabilities of 10%, 60% and 30%, respectively. Calculate expected cash flows assuming
applicable discount rate of 5%, 5.25% and 5.5% in year 1, 2 and 3, respectively.

Q.11: Calculate expected cash flows in each of the following cases:

(a) the estimated amount falls somewhere between ` 50 and ` 250, but no amount in the
range is more likely than any other amount.
(b) the estimated amount falls somewhere between ` 50 and ` 250, and the most likely
amount is ` 100. However, the probabilities attached to each amount are unknown.
(c) the estimated amount will be ` 50 (10 per cent probability), ` 250 (30 per cent
probability), or ` 100 (60 per cent probability).
128 IND AS-36: IMPAIRMENT OF ASSETS

Q.12: X Ltd., is having a plant (asset) carrying amount of which is Rs. 100 lakhs on
31.3.2004. Its balance useful life is 5 years and residual value at the end of 5 years is
Its. 5 lakhs. Estimated future cash flow using the plant in next 5 years are:- For the year
ended on Estimated cash flow (Rs. in lakhs)

For the year ended on Estimated cash flow (Rs. in lakhs)

31.3.2005 50
31.32006 30
31.3.2007 30
31.3.2008 20
31.3.2009 20

Calculate “value in USE” for plant if the discount rate is IO% and also calculate 5 the
recoverable amount if net selling price of plant on 31.3.2004 is Rs. 60 lakhs.

ANSWER:
Present value of future cash flow

Year ended Future Cash Flow Discount @ 10% Rate Discounted cash flow
31.3.2005 50 0.909 45.45
31.3.2006 30 0.826 24.78
31.3.2007 30 0.751 22.53
31.3.2008 20 0.683 13.66
31.3.2009 20 0.620 12.40
118.82
Present value of residual price on 31.3.2009 = 5x 0.620 3.10
Present value of estimated cash flow by use of an asset and 121.92
Residual value, which is called “ value in use”.

If net selling price of plant on 31.3.2004 is Rs. 60 lakhs , the recoverable amount will
be higher of Rs. 121.92 lakhs (value in use) and Rs. 6.60 lakhs (net selling price), hence
recoverable amount is Rs. 121.92 lakhs

Q.13: Hari Ltd. gives following estimates to Cash Flows relating to a Fixed Asset on 31st
December 2013. The Discount Rate is 15%.
 IND AS-36: IMPAIRMENT OF ASSETS 129

Year 2014 2015 2016 2017 2018

Cash Flow (Rs. in Lakhs) 4000 6000 6000 8000 4000

Residual Value at the end of 2018 Rs. 1,000 Lakhs

Fixed Asset purchased on 01.01.2011 Rs. 40,000 Lakhs
Useful Life 8 Years
Net Selling Price on 31.12.2018 Rs. 20,000 Lakhs
Calculate –

(a) Value in Use on 31.12.2013

(b) Carrying Amount at the end of 2013
(c) Recoverable Amount on 31.12.2013
(d) Impairment Loss for the year ended 31.12.2013
(e) Revised Carrying Amount on 31.12.2013
(f) Depreciation charge for the year 2014.

SOLUTION:
1. Computation of Value in Use

Year Cash Flow Discount Rate at 15% Discounted Cash Flow

2014 Rs. 4,000 Lakhs 0.870 Rs. 3480 Lakhs
2015 Rs. 6,000 Lakhs 0.756 Rs. 4,536 Lakhs
2016 Rs. 6,000 Lakhs 0.658 Rs. 3,948 Lakhs
2017 Rs. 8,000 Lakhs 0.572 Rs. 4,576 Lakhs
2018 Rs.4,000 + Rs. 1,000 0.497 Rs. 2485 Lakhs
= Rs. 5000 Lakhs
Value in use Rs. 19,025 Lakhs

2. Computation of Other Particulars

Particulars Rs. Lakhs

1. Original Cost 40,000
2. Depreciation for years 2011, 2012 & 2013 (40000-1,000) x 3/8 (14,625)
3. Carrying Amount on 31.12.2013 (1-2) 25,375
4. Recoverable Amount (Net Selling Price 20,000 (or) Value in Use 19,025 20,000
whichever is higher)
130 IND AS-36: IMPAIRMENT OF ASSETS

5. Impairment Loss – Carrying Amount Less Recoverable Amount (3-4) 5,375

6. Revised Carrying Amount = Old Carrying Amount Less Impairment Loss 20,000
(3-5)
7. Depreciation Charge for 2014 (20,000 – 1,000) ÷ 5 years

Q.14: Upendra Ltd. is the sole manufacturer of Product X. A Particular machine is

exclusively used for production of Product X. The Company had near monopoly of the
Product. A competitor has recently come out with a cheaper substitute of Product X.
The Company is anticipating significant fall in demand for its product and cash flow from
the machine used in production of X is also expected to fall. As per the latest budget
estimates taking the entry of the competitor in consideration, the Operating Pre-Tax
Cash Flows from the Machine expected over next 5 years are Rs. 9 Lakhs Rs. 8 Lakhs Rs. 6
Lakhs, Rs. 5.5 Lakhs and Rs. 5 Lakhs respectively. The expected life of the machine is 10
years. Declining growth rates for future cash flows are estimated from year 6 onwards
at 10%, 20%, 30%, 40%, 60% respectively. The Disposal value (net of expected cost of
disposal) realizable at the end of year 10 is Rs. 1 Lakh. The Machine can be disposed off
immediately for Rs. 25 Lakhs subject to payment of brokerage 2% on disposal value. The
Carrying Amount of the machine on the current date is Rs. 35 Lakhs. Taking the risk
involved in the use of the machine for production of X is consideration, a pre-tax rate of
return of 10% seems to be appropriate. Determine the impairment Loss if any, and give
the Journal Entries in the books of the Company.

SOLUTION:
1. Computation of Value in Use (in Rs.1000s)

Year Operating Cash Flow Disc Factor at 10% Present Value

1. 900 0.909 818.10
2. 800 0.826 660.00
3. 600 0.751 450.0
4. 550 0.683 375.60
5. 500 0.621 310.50
6. 500 – 10% = 450 0.564 253.00
7. 450 – 20% = 360 0.513 184.60
8. 360 – 30% = 252 0.467 117.60
9. 252 – 40% = 151.20 0424 64.11
10. 151.20 – 60% = 60.48 0.386 23.35
10 Disposal Value 100 0.386 38.60
Total 3,297.87
 IND AS-36: IMPAIRMENT OF ASSETS 131

2. Computation of Other Particulars

Particulars Rs. Lakhs

1. Carrying Amount given 35.00
2. Net Selling Price = Sale Price 25,00 less Brokerage at 2% thereon 24.50
3. Recoverable Amount (Net Selling Price 24,50 less (or) Value in Use 32.90
32,97,87 whichever is higher)
4. Impairment Loss = Carrying Amount Less Recoverable Amount (1-3) 2.00

Journal Entries (Rs. 000s)

Particulars Dr. Cr.

Impairment Loss A/c. Dr. 2,02
To Machine A/c. 2.02
(Being Impairment Loss recognized)
Profit & Loss A/c. Dr. 2,02
To Impairment Loss A/c. 2.02
(Being Impairment Loss transferred to Profit & Loss Account)

Q.15: From the following details provided for an asset, find out – (a) the Impairment
Loss (b) Treatment of Impairment Loss, and (c) Current Year Depreciation.

Cost of the Asset Rs. 56 Lakhs Current Carrying Value Rs. 27.30 Lakhs
Life Period useful 10 Years Life remaining useful 3 Years
Salvage Value NIL Recoverable Amount Rs. 12 Lakhs
Upward Revaluation Rs. 14 Lakhs in
done last year

SOLUTION
1. Impairment Loss = Carrying Amount – Recoverable Amount = Rs. 27.30 Lakhs – Rs.
12.00 Lakhs = Rs. 15.30 Lakhs.
2. Treatment of Impairment Loss:
(a) Adjusted against Revaluation Reserve to the extent amount available in the
account.
(b) Balance of Impairment loss, if any debited to Profit & Loss Account.
 132 IND AS-36: IMPAIRMENT OF ASSETS

Particulars Rs. Lakhs

Amount credited to Revaluation Reserve A/c. at the end of 6th year 14.00
Remaining Useful Life of the Asset as at that date (10-6)= 4 years
Amt. transferred to Retained Earnings from Revaluation Reserve every 3.50
year (Rs. 14.00 Lakhs ÷ 4 Years)
(Note: Rs. 3.5 Lakhs is transferred to Retained Earnings, every year till the
useful lie of the Asset)
Balance available in Revaluation Reserve after transferring to R.E. (Rs. 10.50
14.00 – Rs 3.50)
Impairment Loss:
- First Adjusted against balance in Revaluation Reserve. 10.50
- Balance Adjusted to Profit & Loss Account 4.80
(Rs. 15.30 Lakhs – Rs.10.50 Lakhs)

3. Current Year Depreciation:

(Current Carrying Value – Impairment Loss) ÷ Remaining Useful Life of the Asset
= (27.30 – 15.30) ÷ 3 = Rs. 4 Lakhs

Q.16: A Plant was acquired 15 years ago at a cost of Rs. 5 crores. Its Accumulated
Depreciation as at 31.03.20X0 was rs. 4.15 Crores. Depreciation estimated for the
Financial year 20X0-20X1 is Rs. 25 Lakhs. Estimated Net Selling Price as 31.03.20X0 was
Rs. 30 Lakhs, which is expected to decline by 20% by the end of the next Financial year.
Its Value in Use has been computed at Rs. 35 Lakhs as on 01.04.20X0 which is expected to
decrease By 30% by the end of the Financial year.

1. Assuming that other conditions for applicability of the impairment Accounting Standard
are satisfied, what should be the Carrying Amount of this Plant as at 31.03.20X1?
2. How much will be amount of write off for the Financial year to end on 31.03.20X1?
3. If the Plant had been revalued ten years ago and the Current Reserves against this
Plant were to be Rs. 12 Lakhs, how would you answer to questions (1) and (2) above
change?
4. If the Value in Use was zero and the Enterprise were required to incur a cost of Rs.
2 Lakhs to dispose of the Plant, what would be your response to questions (1) and (2)
above?
 IND AS-36: IMPAIRMENT OF ASSETS 133

SOLUTION
1. Balances as on 31.03.20X1 )Rs. Lakhs)

Particulars Net Book Value Net Selling Price Value in Use

As at 31.03.2000 500-415 = 30.00 35.00
Less: Depreciation for 85.00 20% of 30.00 = 30% of 35.00
20X0-20X1 / Reduction 25.00 6.00 = 10.50

Balance on 31.03.20X1 60.00 24.00 24.50

Recoverable Amount = Higher of NSP Vs. VIU = Rs. 24.00 Vs Rs. 24.50 = Rs. 24.50 Lakhs

(a) Recoverable Amount of Rs. 24.50 Lakhs is lower than the Net Book Value of Rs. 60
Lakhs, and hence the Impairment Loss of Rs. 35.50 Lakhs should be recognized in FY
20X0-20X1.
(b) Carrying Amount of the Plant = Book Value Rs. 60 Lakhs Less Impairment Loss Rs.
3550 Lakhs = Rs. 24.50 Lakhs
(c) Amount written off in FY 20X0-20X1 = Depreciation Rs. 25.00 Lakhs + Impairment
Loss Rs. 35.50 Lakhs = Rs. 60.50 Lakhs

2. Treatment if Assets were revalued earlier:

Total Impairment Loss = Rs. 35.50 Lakhs
Adjusted Against Revaluation Reserve = Rs. 12.00 Lakhs
Balance Transferred to P&L A/c. = Rs. 23.50 Lakhs

3. If VIU is Zero (Rs. Lakhs)

Particulars Without Revaluation With Revaluation

Reserve Reserve
Carrying Amount 60.00 60.00
Less: Recoverable Amount = VIU Nil Nil
Impairment Loss 60.00 60.00
Less: Adjusted Against Revaluation Reserve Nil 12.00
Charged to P&L A/c. 60.00 48.00
Add: Additional Provision to be created for 2.00 2.00
Disposal Expenses
Total Debit to P&L A/c. 62.00 50.00
134 IND AS-36: IMPAIRMENT OF ASSETS

PAST EXAMINATION QUESTIONS

QUESTION 1 NOVEMBER 2018

XYZ Limited has three cash- generating units – X, Y and Z, the carrying amounts of which
as on 31st March, 2018 are as follows:
Cash Generating Units Carrying Amount (` in lakh) Remaining useful life in years
X 800 20
Y 1000 10
Z 1200 20
XYZ Limited also has corporate assets having a remaining useful life of 20 years as given
below:
Corporate Carrying amount (` Remarks
Assets in lakh)

AU 800 The carrying amount of AU can be allocated on a rea-

sonable basis to the individual cash generating units.

BU 400 The carrying amount of BU cannot be allocated on

a reasonable basis to the individual cash-generating
units.
Recoverable amounts as on 31st March, 2018 are as follows:
Cash – generating units Recoverable amount (` in lakh)
X 1000
Y 1200
Z 1400
XYZ Limited 3900
Calculate the impairment loss if any of XYZ Ltd. Ignore decimals.

ANSWER (A)
(i) Allocation of corporate assets to CGU

The carrying amount of AU is allocated to the carrying amount of each individual

cash- generating unit, A weighted allocation basis is used because the estimated re-
maining useful life of Y’s cash - generating unit is 10 years, whereas the estimated
remaining useful lives of X and Z’ s cash- generating units are 20 years.

  (` in lakh)
  Particulars X Y Z Total
(a) Carrying amount 800 1000 1,200 3,000
(b) Useful life 20 years 10 years 20 years  
 IND AS-36: IMPAIRMENT OF ASSETS 135

(c) Weight based on 2 1 2  

useful life
(d) Carrying amount 1,600 1,000 2,400 5,000
(after assigning
weight) (a x c)
(e) Pro-rata allocation 32% 20% 48% 100%
of AU
    (1,600/500) (1,000/5,000) (2,400/5,000)  
(f)  Allocation of car- 256 160 384 800
rying amount of AU
(32: 20: 48)
(g)  Carrying amount 1,056 1,160 1,584 3,800
(after allocation of
AU) (a +f)
(ii) Calculation of impairment loss
Step 1: Impairment losses for individual cash- generating units and its allocation
a) Impairment loss of each cash – generating units

(` in lakh)
Particulars X Y Z

Carrying amount (after allocation of AU) 1,056 1,160 1,584

Recoverable amount 1,000 1,200 1,400

Impairment loss 56 Nil 184
b) Allocation of the impairment loss (after rounding off)
(` in lakh)
Allocation to X   Z  
AU 14 (56 x 256/1,056) 45 (184 x 384/1,584)
Other assets in Cash-
42  (56 x 800/1056)   139  
generating units

Impairment loss       (184 x 1,200/ 1,584)

  56   184  
 136 IND AS-36: IMPAIRMENT OF ASSETS

Step 2: Impairment loss for the larger cash- generating unit, i.e., XYZ Ltd. as a
whole

Particulars X Y Z AU BU XYZ Ltd.

Carrying amount 800 1,000 1,200 800 400 4,200

 Impairment loss
(Step 1) -42 ____ -139 (59)* __ -240

 400
Carrying amount
758 1,000 1,061 741 3,960
(after Step 1)
 Recoverable    
    3,960
amount
Impairment loss            60
for the ‘larger’
cash- generating
unit
` 14 lakh + ` 45 lakh = ` 59 lakh.

QUESTION 2 NOVEMBER, 2018 EXAM

A Machine was acquired by ABC Ltd. 15 years ago at a cost of ` 20 crore. Its accumulated
depreciation as at 31st March, 2018 was ` 16.60 crore. Depreciation estimated for the
financial year 2018-19 is ` 1 crore. Estimated Net Selling Price of the machine as on 31st
March, 2018 was ` 1.20 corer, which is expected to decline by 20 per cent by the end of
the next financial year.
Its value in use has been computed at ` 1.40 crore as on 1stApril, 2018, which is expected to
decrease by 30 per cent by the end of the financial year. Assuming that other conditions
of relevant Accounting Standard for applicability of the impairment are satisfied:
(i) What should be the carrying amount of this machine as at 31st March, 2019?

(ii) How much will be the amount of write of (impairment loss) for the financial year ended
31st March, 2019?

(iii) If the machine had been revaluation ten years ago and the current revaluation re-
serves against this plant were to be ` 48 lakh, how would you answer to questions (i)
and (ii) above?

(iv) If the value in use was zero and the company was required to incur a cost of ` 8 lakh
to dispose of the plant, what would be your response to questions (i) and (ii) above?
Answer (A) As per the requirement of the question, the following solution has been drawn
on the basis of AS 28
 IND AS-36: IMPAIRMENT OF ASSETS 137

  (` in crore)

(i)       Carrying amount of plant (before impairment) as on 31st March, 2019 2.4

Carrying amount of plant (after impairment) as on 31st March, 2019  0.98

(ii)      Amount of impairment loss for the financial year ended 31st March
1.42 
2019 (2.4 Cr.- 0.98 Cr)
 
(iii)    If the plant had been revalued ten years ago

Debit to revaluation reserve 0.48

Amount charged to profit and loss (1.42 – 0.48)  0.94

(iv)     If Value in use was zero  

Value in use (a)  Nil
Net selling price (b) -0.08 
Recoverable amount [higher of (a) and (b)]  Nil

Carrying amount (closing book value) Nil

Amount of write off (impairment loss) (` 2.4 Cr – Nill)  2.4

Entire book value of plant will be written off and charged to profit
 
and loss account.
Working Notes:
(1) Calculation of Closing Book Value, as at 31st March, 2019

  ` in crore
Opening book value das on 1.4.2018 (` 20 crore - 16.60 crore) 3.40
Less: Depreciation for financial year 2018-2019 -1
Closing book value as on 31.3.2019 (before Impairment) 2.40

(2) Calculation of Estimated Net Selling Price on 31st March, 2019

` in crore
Estimated net selling price as on 1.4.2018 1.20
Less: Estimated decrease during the year (20% of ` 1.20 Cr.) (0.24)
Estimated net selling Price as on 31.3.2019 0.96

(3) Calculation of Estimated Value in Use of Plant on 31st March, 2019

` in crore
Estimated value on use as on 1.4. 2018 1.40
Less: Estimated decrease during the year (30% of ` 1.40 Cr.) (0.42)
Estimated value in use as on 31.3.2019 0.98
138 IND AS-36: IMPAIRMENT OF ASSETS

(4) Recoverable amount as on 31.3.2019 is equal to higher of Net selling price and
value in use

  ` in core
Net selling price 0.96
Value in use 0.98
Recoverable amount 0.98
Impairment Loss [Carrying amount- Recoverable amount ie. 1.42
(2.40 Cr. – 0.98 Cr)]
Revised carrying amount on 31.3.2019 is equal to Recoverable 0.98 Cr. 
amount (after impairment)
 IND AS-38: INTANGIBLE ASSETS 139

IND AS-38: INTANGIBLE ASSETS

Non-monetary asset

Without physical
Identifiable substance

Intangible
Asset

Entities frequently expend resources, or incur liabilities, on the acquisition, development,

maintenance or enhancement of intangible resources such as:
• Scientific or technical knowledge
• Design and implementation of new processes or systems
• Licences
• Intellectual property
• Market knowledge and trademarks (including brand names and publishing titles).
Common examples of items encompassed by these broad headings are:
• Computer software
• Patents
• Copyrights
• Motion picture films
• Customer lists
• Mortgage servicing rights
• Fishing licences
• Import quotas
• Franchises
• Customer or supplier relationships
• Customer loyalty
• Market share and marketing rights.
140 IND AS-38: INTANGIBLE ASSETS

  QUESTION 1: IDENTIFIABILITY

Sun Ltd has an expertise in consulting business. In past years, company has gained a market
share for its services of 30 percent and considers recognising it as an intangible asset. Is
the action by company is justified?

SOLUTION:
Market share does not meet the definition of intangible assets as is not identifiable i.e. It
is neither separable and nor arised from contractual or legal rights.

  QUESTION 2: CONTROL

Company XYZ ltd has provided training to its staff on various new topics like GST, Ind AS
etc to ensure the compliance as per the required law. Can the company recognise such cost
of staff training as intangible asset?

SOLUTION:
It is clear that the company will obtain the economic benefits from the work performed by
the staff as it increases their efficiency. But it does not have control over them because
staff could choose to resign the company at any time.
Hence the company lacks the ability to restrict the access of others to those benefits.
Therefore, the staff training cost does not meet the definition of an intangible asset.

  QUESTION 3: IDENTIFIABILITY OF INTANGIBLE ASSETS

Pluto Ltd. intends to open a new retail store in a new location in the next few weeks. Pluto
Ltd has spent a substantial sum on a series of television advertisements to promote this
new store. The Company has paid an amount of ` 800,000 for advertisements before 31
March 20X1. ` 700,000 of this sum relates to advertisements shown before 31 March 20X1
and ` 100,000 to advertisements shown in April 20X1. Since 31 March 20X1, The Company
has paid for further advertisements costing ` 400,000.
Pluto Ltd is of view that such costs can be carried forward as intangible assets. Since market
research indicates that this new store is likely to be highly successful. Please explain and
justify the treatment of the above costs in the financial statements for the year ended 31
March 20X1.

SOLUTION:
Under Ind AS 38 – Intangible Assets – intangible assets can only be recognised if they are
identifiable and have a cost which can be reliably measured.
These criteria are very difficult to satisfy for internally developed intangibles.
For these reasons, Ind AS 38 specifically prohibits recognising advertising expenditure as
 IND AS-38: INTANGIBLE ASSETS 141

an intangible asset. The issue of how successful the store is likely to be does not affect
this prohibition. Therefore such costs should be recognised as expenses.
However, the costs would be recognised on an accruals basis. Therefore, of the
advertisements paid for before 31 March 20X1, ` 700,000 would be recognised as an
expense and ` 100,000 as a pre-payment in the year ended 31 March 20X1. The ` 400,000
cost of advertisements paid for since 31 March 20X1 would be charged as expenses in the
year ended 31 March 20X2.

  QUESTION 4

Mercury Ltd is preparing its accounts for the year ended 31 March 20X2 and is unsure
about how to treat the following items.

1. The company completed a grand marketing and advertising campaign costing ` 4.8
Lakh. The finance director had authorised this campaign on the basis that it would
create ` 8 lakh of additional profits over the next three years.
2. A new product was developed during the year. The expenditure totalled ` 3 lakh of
which ` 1.5 lakh was incurred prior to 30 September 20X1, the date on which it became
clear that the product was technically viable. The new product will be launched in the
next four months and its recoverable amount is estimated at ` 1.4 lakh.
3. Staff participated in a training programme which cost the company ` 5 lakh. The
training organisation had made a presentation to the directors of the company outlining
that incremental profits to the business over the next twelve months would be ` 7
lakh.
What amounts should appear as intangible assets in accordance with Ind AS 38 in Mercury’s
balance sheet as on 31 March 20X2?

SOLUTION:
The treatment in Mercury’s financials as at 31 March 20X2 will be as follows:

1. Marketing and advertising campaign: no intangible asset will be recognised, because it

is not possible to identify future economic benefits that are attributable only due to
this campaign. All of the expenditure should be expensed in the statement of profit
and loss.
2. New product: development expenditure appearing in the balance sheet will be valued at
` 1.5 lakh. The expenditure prior to the date on which the product becomes technically
feasible is recognised in the statement of profit and loss.
3. Training programme: no asset will be recognised, because there is no control of the
company over the staff and when staff leaves the benefits of the training, whatever
they may be, also departs.
142 IND AS-38: INTANGIBLE ASSETS

  QUESTION 4: SEPARATE ACQUISITION

Venus India Private Ltd acquired a software for its internal use costing `10,00,000. The
amount payable for the software was ` 600,000 immediately and ` 400,000 in one year
time. The other expenditure incurred were:-
Purchase tax : ` 1,00,000
Entry Tax : 10% ( recoverable later from tax department) Legal fees: ` 87,000
Consultancy fees for implementation : ` 1,20,000 cost of capital of the company is 10%.
Calculate the cost of the software on initial recognition using the principles of Ind AS 38
Intangible Assets.

  QUESTION 5: BUSINESS COMBINATION

On 31st March 20X1, Earth India Ltd paid ` 50,00,000 for a 100% interest in Sun India Ltd.
At that date Sun Ltd’s net assets had a fair value of `30,00,000. In addition, Sun Ltd also
held the following rights:
Trade Mark named “GRAND” – valued at ` 180,000 using a discounted cash flow technique.
Sole distribution rights to an electronic product. Future cash flows from which are estimated
to be ` 150,000 per annum for the next 6 years.
10% is considered an appropriate discount rate. The 6 year, 10% annuity factor is 4.36.
Calculate goodwill and other Intangible assets arising on acquisition.

  QUESTION 6: EXCHANGE OF ASSET

Sun Ltd acquired a software from Earth Ltd. in exchange for a telecommunication license.
The telecommunication license is carried at `5,00,000 in the books of Sun Ltd. The Software
is carried at ` 10,000 in the books of the Earth Ltd which is not the fair value.
Advise journal entries in the following situations in the books of Sun Ltd and Earth Ltd:-
1) Fair value of software is ` 5,20,000 and fair value of telecommunication license is `
5,00,000.
2) Fair Value of Software is not measureable. However similar Telecommunication license
is transacted by another company at ` 4,90,000.
3) Neither Fair Value of Software nor Telecommunication license could be reliably measured.
 IND AS-38: INTANGIBLE ASSETS 143

  QUESTION 7: DEVELOPMENT PHASE

Expenditure on a new production process in 20X1-20X2:

INR
1st April to 31st December 2,700
1st January to 31st March 900
3,600

The production process met the intangible asset recognition criteria for development on 1st
January 20X2. The amount estimated to be recoverable from the process is ` 1,000.
What is the carrying amount of the intangible asset at 31st March 20X2 and the charge to
profit or loss for 20X1-20X2?
Expenditure incurred in FY 20X2-20X3 is ` 6,000.
At 31st March 20X3, the amount estimated to be recoverable from the process (including
future cash outflows to complete the process before it is available for use) is ` 5,000.
What is the carrying amount of the intangible asset at 31st March 20X3 and the charge to
profit or loss for 20X2-X3?

  QUESTION 8 : REVALUATION MODE L

1. Saturn Ltd. acquired an intangible asset on 31st March 20X1 for ` 1,00,000. The asset
was revalued at ` 1,20,000 on 31st March 20X2and ` 85,000 on 31st March 20X3.
2. Jupiter Ltd. acquired an intangible asset on 31st March 20X1 for ` 1,00,000. The asset
was revalued at ` 85,000 on 31st March 20X2 and at ` 1,05,000 on 31st March 20X3.
Assuming that the year -end for both companies is 31 st March, and that they both use the
revaluation model, show how each of these transactions should be dealt with in the financial
statements.

  QUESTION 9

X Limited engaged in the business of manufacturing fertilisers entered into a technical

collaboration agreement with a foreign company Y Limited. As a result, Y Limited would
provide the technical know-how enabling X Limited to manufacture fertiliser in a more
efficient way. X Limited paid ` 10,00,00,000 for the use of know-how for a period of 5
years. X Limited estimates the production of fertiliser as follows:
 144 IND AS-38: INTANGIBLE ASSETS

Year (in metric tons)

1 50,000
2 70,000
3 1,00,000
4 1,20,000
5 1,10,000

At the end of the 1st year, it achieved its targeted production. At the end of 2nd year,
65,000 metric tons of fertiliser was being manufactured, and X Limited considered to
revise the estimates for the next 3 years. The revised figures are 85,000, 1,05,000 and
1,15,000 metric tons for year 3, 4 & respectively.
How will X Limited amorise the technical know-how fees as per Ind AS 38?

  QUESTION 10

X Ltd. purchased a patent right on April 1, 20X1, for ` 3,00,000; which has a legal life of 15
years. However, due to the competitive nature of the product, the management estimates
a useful life of only 5 years. Straight-line amortisation is determined by the management
to be the best method. As at April 1, 20X2, management is uncertain that the process
can actually be made economically feasible, and decides to write down the patent to an
estimated market value of ` 1,50,000 and decides to amortise over 2 years. As at April 1,
20X3, having perfected the related production process, the asset is now appraised at a
value of ` 3,00,000. Furthermore, the estimated useful life is now believed to be 4 more
years. Determine the value of intangible asset at the end of each financial year?

  QUESTION 11

X Pharmaceutical Ltd. seeks your opinion in respect of following accounting transactions:

1. Acquired a 4 year license to manufacture a specialised drug at a cost of ` 1,00,00,000

at the start of the year. Production commenced immediately.
2. Also purchased another company at the start of year. As part of that acquisition the
company acquired a brand with a FV of ` 3,00,00,000 based on sales revenue. The life
of the brand is estimated at 15 years.
3. Spent ` 1,00,00,000 on an advertising campaign during the first six months. Subsequent
sales have shown a significant improvement and it is expected this will continue for
3 years.
4. It has commenced developing a new drug ‘Drug-A’. The project cost would be
` 10,00,00,000. Clinical trial proved successful and such drug is expected to generate
revenue over the next 5 years.
 IND AS-38: INTANGIBLE ASSETS 145

Cost incurred (accumulated) till March 31, 20X1 is ` 5,00,00,000.

Balance cost incurred during the financial year 20X1-20X2 is ` 5,00,00,000.
5. It has also commenced developing another drug ‘Drug B’. It has incurred `50,00,000
towards research expenses till March 31, 20X2. The technological feasibility has not
yet been established.
How the above transactions will be accounted for in the books of account of X Pharmaceutical
Ltd?

SOLUTION:

1. It should recognize the drug license as an intangible asset, because it is a separate

external purchase, separately identifiable asset and considered successful in respect
of feasibility and probable future cash inflows.
The drug license should be recorded at 1,00,00,000.
2. It should recognize the brand as an intangible asset because it is purchased as a part
of acquisition and it is separately identifiable. The brand should be amortized over a
period of 15 years. The brand will be recorded at 3,00,00,000.
3. The advertisement expenses of 1,00,00,000 should be expensed off.
4. The development cost incurred during the financial year 20X1-X2 should be capitalized.
Cost of intangible asset (Drug A) (5crore+5crore=10Crores)
5. Research Expenses of 50,00,000 incurred for developing Drug B should be expenses
off since technological feasibility has not yet established.

  QUESTION NO 12

A Ltd. is developing a new production process. It has incurred the following expenditure.
Find out value of Intangible Assets.

Date Particulars Amount (Rs. in lacs)

Upto 31 March Research expenditure when intention to 20
2001 commercialise was not establish
2001-02 Development expenses
Salaries and wages 30
Overheads 12
Staff Training 10
Apportioned Administrative Expenses 10
2002-03 Salary and wages 40
Recoverable Amount (AS-28) 70
146 IND AS-38: INTANGIBLE ASSETS

  QUESTION NO 13

An enterprise is developing a new production process. During the year 2001, expenditure
incurred was Rs. 10 lakhs, of which Rs. 9 lakhs was incurred before 1 December 2001 and
1 lakh was incurred between 1 December 2001 and 31 December 2001. The enterprise is
able to demonstrate that, at 1 December 2001, the production process met the criteria for
recognition as an intangible asset. The recoverable amount of the know-how embodied in
the process (including future cash outflows to complete the process before it is available
for use) is estimated to be Rs. 5 lakhs.

ANSWER:
At the end of 2001, the production process is recognized as an intangible asset at a cost
of Rs. 1 lakh (expenditure incurred since the date when the recognition criteria were met,
that is, 1 December 2001). The Rs. 9 lakhs expenditure incurred before 1 December 2001
is recognized as an expense because the recognition criteria were not met until 1 December
2001. This expenditure will never form part of the cost of the production process recognized
in the balance sheet.

  QUESTION NO 14

A pharma company spent Rs. 33 lakhs during the year to develop a drug on AIDS. It will
take four years to establish whether the drug will be successful. The company wants to
treat the expenditure as deferred revenue expenditure.

ANSWER
With the introduction of IND AS 38, the concept of deferred revenue expenditure does
not any more exist barring few exceptions. In the given case, the pharma company should
not capitalise Rs. 33 lakhs since capitalization conditions as per IND AS 38 are not fulfilled.
The same should charged to the P&L account.

  QUESTION NO 15

A company with a turnover of Rs. 250 crores and an annual advertising budget of Rs. 2 crore
had taken up the marketing of a new product. It was estimated that the company would
have a turnover of Rs. 25 crores from the new product. The company had debited to its
Profit and Loss Account the total expenditure of Rs. 2 crore incurred on extensive special
initial advertisement campaign for the new product.
Is the procedure adopted by the company correct ?

ANSWER:
With the introduction of IND AS 38 - “Intangible Assets’, the concept of deferred revenue
expenditure no longer prevails except in respect of a very few items, such as ancillary costs
 IND AS-38: INTANGIBLE ASSETS 147

on borrowings, share issue expenses, etc. IND AS 38 does not permit the capitalization of
expenses incurred on advertising or brand promotion, etc. Thus the accounting treatment
by the company of debiting the entire advertising expenditure of Rs. 50 lakhs to the profit
and loss account of the year is correct.

  QUESTION NO 16 (R&D WITH IMPAIRMENT LOSS)

Ganguly International Ltd. is developing a new production process. During the financial
year ended 31st March 2004, the total expenditure incurred on this process was Rs. 50
lakhs. The production process met the criteria for recognition as an intangible asset on 1st
December 2003. Expenditure incurred till this date was Rs. 22 lakhs.
Further expenditure incurred on the process for the financial year ending 31st March
2005 was Rs. 80 lakhs. As at 31st March 2005, the recoverable amount of the know-how
embodied in the process is estimated to be Rs. 72 lakhs. This includes estimates of future
cash outflow as well as inflows :

You are required to work out :

What is the expenditure to be charged to the P &L Account for the financial year ended
31st March 2004 ? (Ignore depreciation for this purpose)

(i) What is the carrying amount of the intangible asset as at 31st March 2004 ?
(ii) What is the expenditure to be charged to the P &L Account for the financial year
2005 (Ignore depreciation for this purpose)
(iii) What is the carrying amount of the intangible asset as at 31st March 2005 ?

SOLUTION:

(a) Expenditure incurred up to 1.12.2009 will be taken up to profit and loss account for
the financial year ended 31.3.2010 = Rs. 22 Lakhs.
(b) Carrying amount as on 31.3.2010 will be the expenditure incurred after 1.12.2009 = Rs.
28 Lakhs.
(c) Book cost of intangible asst as on 31.3.2011 is worked out as:
Carrying amount as on 31.3.2010 - Rs. 28 Lakhs
Expenditure during 2010-11 - Rs. 80 Lakhs
Total Book Cost - Rs. 108 Lakhs
Recoverable amount, as estimated - Rs. 72 Lakhs
Difference to be charged to Profit and loss account as impairment.
(d) Carrying amount as on 31.3.2011 will be (cost less Impairment loss) Rs. 72 Lakhs
 148 IND AS-38: INTANGIBLE ASSETS

  QUESTIO NO 17

Sunny Limited is developing a now production process. During the financial year ended 31st
March 2013, the Company has incurred total expenditure of Rs. 40 Lakhs on the process.
On 1st December 2012, the process has met the norms to be recognized as “Intangible
Assets” and the expenditure incurred till that date is Rs. 16 Lakhs. During the financial year
ending on 31st March 2014, the Company has further incurred Rs. 70 Lakhs.T he Recoverable
Amount as on 31st March 2014 of the process is estimated to be Rs. 62 Lakhs. You are
required to work out:

(i) Expenditure to be charged to Profit and Loss Account for the financial year ending on
31st March 2013and31st March 2014 (ignore Depreciation).
(ii) Carrying Amount of the Intangible Assets as at 31st March 2013 and 31st March 2014.

SOLUTION:

1. Expenditure charged to P&L for 2012-2013: Rs. 16 Lakhs will be recognized as an

Expense because the recognition criteria were not met until1st December 2012. The
expenditure will not form part of the cost of the Production Process recognized in the
Balance Sheet.
2. Carrying Amount of Intangible Asset as on 31.03.2013: The Production Process will be
recognized (i.e. Carrying Amount), as an Intangible Asset at a cost of Rs. 24 Lakhs (i.e.
expenditure incurred till the date in which recognition criteria were met, i.e. Total
during FY 2012-2013 Rs. 40 Lakhs less Expenses upto 1st Dec. 2012 Rs. 16 Lakhs).
3. Expenditure charged to P&L A/c. for 2013-2014:

Particulars Rs. Lakhs

Book Value on 31.3.2014 = Carrying Amt. on 31.3.2013 + Expenditure 94
in 2013-2014 = 24 ÷ 70
Less: Recoverable Amount 62
Impairment Loss to be charged to P&L A/c. 32

4. Carrying Amount of Intangible Asset as on 31.03.2014: The Production Process will be

shown at Book value Rs. 94 Lakhs, or Recoverable Amount Rs. 62 Lakhs, whichever is
less, hence at Rs. 62 Lakhs as above.

  QUESTION NO 18

An Enterprise has incurred expense for purchase of Technical Know-how for manufacturing
a Moped. The Enterprise has paid Rs. 5 crores for the use of Know-how for a period of 4
years. The Enterprise estimates the production of mopeds as follows :
 IND AS-38: INTANGIBLE ASSETS 149

Year No. of Mopeds

1 25,000
2 50,000
3 75,000
4 1,00,000

On going into production, at the end of the 1st year it achieved its targeted production, but
considered to revise the estimates for the next 3 years as follows :

Year No. of Mopeds

1 35,000
2 65,000
3 80,000

(a) How will the Enterprise amortise the Technical Know-how Fees as per A IND AS 38
(b) Whether this amortisation should be directly charged as an expense or should form
part of Production Cost of the Mopdes.

ANSWER:
Based on the revised estimate, total sales is 2,05,000 the first year charge should be a
proportion of 25,000 / 2,05,000 on Rs. 5 crores, second year will be 35,000 / 2,05,000,
and so on unless the estimates are again revised. If these estimates cannot be determined
reliably it would be preferable to charge them off on a straight line basis, otherwise, as
can be seen from the above example, significant amortisation amount is inappropriately
postponed to later years. As already mentioned above, there will rarely, if ever, be persuasive
evidence to support an amortisation method for intangible assets that results in a lower
amount of accumulated amortisation than under the straight-line method. In the given case,
amortisation expense will be included as cost of inventory.

  QUESTION NO 19

Swift Ltd. acquired a Patent at a cost of Rs. 80,00,000 for a period of 8 years and the
product life-cycle is also 8 years. The company capitalized the cost and started amortizing
the asset at Rs. 10,00,000 per annum. After two years it was found that the product life-
cycle may continue for another 5 years from then. The net cash flows from the product
during these 5 years were expected to be Rs. 36,00,000; Rs. 46,00,000; Rs. 44,00,000;
Rs. 40,00,000 and Rs. 34,00,000. Find out the amortization cost of the patent for each of
the years.
 150 IND AS-38: INTANGIBLE ASSETS

Hint: Ratio of cash inflow should be used to write off the intangible asset of 60,00,000
(36:46:44:40:34).

SOLUTION:
As per IND AS 38 “Intangible Assets”, the amortization method used should reflect the
pattern in which the asset’s economic benefits are consumed by the enterprise, if that
pattern cannot be determined reliably, the straight-line method should be used.
In the instant case, pattern of economic benefit in the form of net cash flows is determined
reliably after two years. In the initial two years the pattern of economic benefits could
not have been reliably estimated therefore amaoritzation was done at straight-line method
i.e. Rs. 10 Lakhs per annum. However, after two years pattern of economic benefits for
next five years in the form net cash flows is reliably estimated as under and therefore
amortization will also be done as per the pattern of cash in flows:-

Cash in flows (Rs.) Amt. of amortization in next 5 years (Rs.) Balance WDV
36,00,000 10,80,000 (60,00,000 x 36,00,000/200,00,000)
46,00,000 13,80,000 (60,00,000 x 46,00,000/200,00,000)
44,00,000 13,20,000 (60,00,000 x 44,00,000/200,00,000)
40,00,000 12,00,000 (60,00,000 x 40,00,000/200,00,000)
34,00,000 10,20,000 (60,00,000 x 34,00,000/200,00,000)
200,00,000 60,00,000

  QUESTION NO 20

While executing a new project, the company had to pay Rs. 50 lakhs to the State Government
as part of the cost of roads built by the State Government in the vicinity of the project
for the purpose of carrying machinery and materials to the project site. The road so built
is the property of the State Government.
Advice the company about the accounting treatment.
Hint: Refer class notes on toll road licence accounting as per schedule ii given in ppe ind
as 16

  QUESTION NO 21

During the Financial year 2014-2015, Power Ltd. had the following transactions.

(i) ON 01.04.2014 Power Ltd. purchased a new Asset of Dark Ltd. for Rs. 11,40,000. The
fair Value of Dark Ltd.’s identifiable Net Assets was Rs. 8,50,000. Power Ltd. is of the
view that due to popularity of Dark Ltd.’s product the life of Goodwill is 10 years.
 IND AS-38: INTANGIBLE ASSETS 151

(ii) On 01.05.2014 Power Ltd. purchased a franchise to operate Transport Service from
the Government for Rs. 12,00,000 and at a Annual Fee of 4% of Transport Revenues.
The Franchise expires after 5 years. Transport Revenue were Rs.1,20,000 for Financial
year 2014-2015. Power Ltd. projects future Revenue of Rs. 2,40,000 in 2015-2016
and Rs. 3,50,000 p.a. for 3 years thereafter.
(iii) On 5.07.2014, Power Ltd. was granted a Patent that had been applied for by Dark
Ltd. During 2014-2015, Power Ltd. incurred Legal Cost of Rs. 1,10,000 to register the
Patent and an additional Rs.3,00,000 to successfully prosecute a Patent infringement
suit against a Computer. Power Ltd. expects the Patent’s economic lie to be 10 years.
Power Ltd. follows an Accounting Policy to amortize all Intangibles on SLM basis over
a maximum period permitted by Accounting Standard, taking a full year amortization
in the year of acquisition.
Prepare:

(a) A Schedule showing the intangible section in Power Ltd. Balance Sheet at 31st March
2015.
(b) A Schedule showing the related expense that would appear in the Statement of Profit
and Loss of Power Ltd. for 2014-2015.
SOLUTION:

1. Treatment under IND AS 38

Point Principle and Treatment (amounts in Rs.000s)

(i) * The excess of consideration paid over the Fair value of identifiable Net
Asset is recognized as Goodwill, Hence, Goodwill= 1140-850=290.
* IND AS 38 assumes that the useful life does not exceed 10 years. So, the
amortization over 10 years is proper.
290
Amortisation p.a. = = 29
10

(ii) • Lumpsum franchise fee 1200 would be recognized as Intangibel Asset.

• The Depreciation Amount should be allocated over the assets useful i.e, on a
systematic basis, (e.g. SLM, or Radio of Revenues to be earned, etc.)
• In this case Total Revenues to be earned in 5 years are –
Year 1 2 3 4 5 Total
Revenue Amortisation 120 240 350 350 350 1410
Apportioned 102 204 298 298 298 1200

• Alternatively, Amortisation p.a. under SLM = 1200 / 5 = 240

152 IND AS-38: INTANGIBLE ASSETS

• Revenue in each year and 4% Annual Fee should be recognized as Income/

Expenses in P&L of each year.
Note: Impairment Testing nor considered in this cases.
(iii) • Cost of Patent = Registration + Directly attributable Cost = 110+300=410
• Amortisation p.a. = 410 /10 years = 41
• Note: Assumed that 410 represents cost relating to right to use, and
hence capitalized under IND AS 38.

2. Balance Sheet of Power Ltd. (extract) (Rs.000)

Particulars as at 31st March 2015 Note This Year Prev. Yr.

II ASSETS 1,728
(1) Non-Current Assets: Intangible Assets 1
Total XXXX

Note for WN 2: Intangible Assets : (Rs 000s)

Particulars Gross Block (Cost) Accumulated Amortisation Net Block

Opg Addns Closing Opg. Addns Closing Opg. Closing
Bal. Bal. Bal Bal. Bal. Bal.
(a) Goodwill - 290 290 - 29 29 - 261
(b) Transport - 1200 1200 - 102 102 - 1098
Franchise
(c) Patent - 410 410 - 41 41 - 369
Total - 1900 1900 - 172 172 - 1728

3. Profit and Loss Statement (extract) (Rs 000)

Particulars as at 31st March 2015 Note This Year Prev. Yr.

Depreciation and Amortisation Expense 1 172
Total XXXX
 IND AS-38: INTANGIBLE ASSETS 153

Note:

1. Depreciation and Amortisation Expenses

(a) Goodwill 20
(b) Transport Service Franchise 102
(c) Patent 41 172

  QUESTION NO 22

Srimathi Ltd. acquired patent right for Rs. 400 Lakhs. The product life cycle has been
estimated to be 5 yeas and the amortization was decided in the ratio of estimated future
cash flows which are as under:-

Year 1 2 3 4 5
Estimated Future Cash Flows 200 200 200 100 100
(Rs. in Lakhs)

After the 3rd year, it was ascertained that the Patent would have an estimated balance
future life of 3 years and the Estimated Cash Flow after 5thyear is expected to be Rs. 50
Lakhs each year. Determine the amortization under IND AS 38.

SOLUTION:

1. Initial Estimate of Total Cash Inflow = 200+200+200+100+100= Rs. 800 Lakhs.

2. So, as per initial estimate, the cost of Patent should be written off in the ratio 2:2:2:1:1
i.e. (Rs. Lakhs) 100, 100, 100, 50 and 50 respectively, for the five years.
3. Unamortised Amount (WDV) of Patent at the end of 3rd year = 400 – (100+100+100) =
Rs. 100 Lakhs.
4. Revised Estimate of Useful Life at the end of 3rd year = 3 future years, with estimated
Cash Inflows being as under – Year 4 Rs. 100 Lakhs Year 5 Rs. 100 Lakhs, year 6: Rs.
50 Lakhs.
5. Hence, the unamortized Carrying Amount should be written off over the next 3 years,
in the ratio of 100:100:50, i.e. Rs. 40 Lakhs, Rs. 40 Lakhs and Rs. 20 Lakhs respectively
for years 4,5 and 6.
Hence, If it is assumed that the Patent Right is not renewable, the present unamortized
amount of Rs. 100 Lakhs may be written off in years 4 and 5, as per initial estimate, at Rs.
50 Lakhs p.a.
154 IND AS-38: INTANGIBLE ASSETS

  QUESTION NO 23

Preetha Ltd. got a license to manufacture certain medicines for 10 years at a License Fee of
Rs. 200 Lakhs. Given below is the pattern of expected production and expected Operating
Cash Inflow:

Year Production in Bottles Net Operating Cash Flow

(in Lakhs) (Rs. in Lakhs)
1 300 900
2 600 1800
3 650 2300
4 to 10 800 p.a. 3200 p.a.

Net Operating Cash Flow has increased for third year because of better Inventory
management and handling method. Suggest the amortization method.

SOLUTION:
As per IND AS 38, Amortisation Method should be based on the expected pattern of
consumption of economic benefits. Hence, the ratio of Net Operating Cash Flow can be used
for amortization purposes.

Year Net Operating Cash Amortisation Amt.

Flow (Rs. in Lakhs)
(in above ratio)
1 900 6
2 1,800 12
3 2,300 16
4 3,200 24
5 3,200 24
6 3,200 24
7 3,200 24
8 3,200 24
9 3,200 24
10 3,200 22 (bal. fig)
Total 27,400 200
 IND AS-38: INTANGIBLE ASSETS 155

  QUESTION NO 24

A Company has deferred R&D Cost of Rs. 150 Lakhs. Sales expected in the subsequent
years are as under:-

Year I II III IV
Sales (Rs. in Lakhs) 400 300 200 100

Suggest how R&D Cost should be charged to Profit & Loss Account. Also, if at the end of the
III year, it is felt that no further benefit will accrue in the IV year, how the unamortized
expenditure would be dealt with in the accounts of the Company?

SOLUTION:

1. The Deferred Research and Development costs is to be charged to P&L A/c. on the
basis of Expected Sales as follows:-

Year Sales Percentage of R&D Costs to be Amount charged to P&L

(Rs. Lakhs) amortized in each year Account (Rs. Lakhs)
(on the basis of Sales)
I 400 40% 150x40% = 60
II 300 30% 150x30% = 45
III 200 20% 150x20% = 30
IV 100 10% 150x10% = 15

2. Requirements under IND AS 38:

(a) The period of Amortization should be reviewed periodically to determine proper
method of amortization.
(b) Change of Amortization period: If the expected benefit from the asset is
significantly different from the previous estimates, the amortization period
should be changed accordingly.
156 IND AS-38: INTANGIBLE ASSETS

EXTRA QUESTIONS TO BE COVERED

Q.1: X Ltd. is engaged in the business of publishing Journals. They acquired 50%
stake in Y Ltd., a company in the same industry. X Ltd. paid purchase consideration of `
10,00,00,000 and fair value of net asset acquired is ` 8,50,00,000. The above purchase
consideration includes:

(a) ` 30,00,000 for obtaining the skilled staff of Y Ltd.

(b) ` 50,00,000 by way of payment towards ‘Non-compete Fee’ so as to restrict Y Ltd. to
compete in the same line of business for next 5 years.
How should the above transactions be accounted for by X Ltd?

Q.2: X Ltd. purchased a franchise from a restaurant chain at a cost of `1,00,00,000 and
the franchise has 10 years life. In addition, the franchise agreement mentions that the
franchisee would also pay the franchisor royalty as a percentage of sales made. Can the
franchise rights be treated as an intangible asset under Ind AS 38?

Q.3: An entity regularly places advertisements in newspapers advertising its products

and includes a reply slip that informs individuals replying to the advertisement that the
entity may pass on the individual’s details to other sellers of similar products, unless the
individual ticks a box in the advertisement.
Over a period of time the entity has assembled a list of customers’ names and addresses.
The list is provided to other entities for a fee. The entity would like to recognise an asset
in respect of the expected future economic benefits to be derived from the list. Can the
customer list be treated as an intangible asset under Ind AS 38?

Q.4: A software company X Ltd. is developing new software for the telecom industry. It
employs 100 employs engineers trained in that particular discipline who are engaged in the
development of the software. X Ltd. feels that it has an excellent HR policy and does not
expect any of its employees to leave in the near future. It wants to recognise these set
of engineers as a human resources asset in the form of an intangible asset. What would
be your advice to X Ltd?

Q.5: X Ltd. has acquired a telecom license from Government to operate mobile telephony
in two states of India. Can the cost of acquisition be capitalised as an intangible asset
under Ind AS 38?

Q.6: X Ltd. purchased a standardised finance software at a list price of `30,00,000

and paid `50,000 towards purchase tax which is non refundable. In addition to this, the
 IND AS-38: INTANGIBLE ASSETS 157

entity was granted a trade discount of 5% on the initial list price. X Ltd. incurred cost of
` 7,00,000 towards customisation of the software for its intended use. X Ltd. purchased
a 5 year maintenance contract with the vendor company of ` 2,00,000. At what cost the
intangible asset will be recognised?

Q.7: X Limited in a business combination, purchased the net assets of Y Limited for `
4,00,000 on March 31, 20X1. The assets and liabilities position of Y Limited just before
the acquisition is as follows:

Assets Cost (in `)

Property, Plant & Equipment 1,00,000
Intangible asset 1 20,000
Intangible asset 2 50,000
Cash & Bank 1,30,000
Liabilities
Trade payable 50,000

The fair market value of the PPE, intangible asset 1 and intangible asset 2 is available and
they are ` 1,50,000, ` 30,000 and ` 70,000 respectively.
How would X Limited account for the net assets acquired from Y Limited?

Q.9: X Ltd. acquired Y Ltd. on April 30, 20X1. The purchase consideration is `50,00,000.
The fair value of the tangible assets is ` 45,00,000. The company estimates the fair value
of “in-process research projects” at `10,00,000. No other Intangible asset is acquired
by X Ltd. in the transaction. Further, cost incurred by X Ltd. in relation to that research
project is as follows:

(a) ` 5,00,000 – as research expenses

(b) ` 2,00,000 – to establish technological feasibility
(c) `7,00,000 – for further development cost after technological feasibility is
established.
At what amount the intangible asset should be measured under Ind AS 38?

Q.10: X Ltd. acquired a patent right of manufacturing drug from Y Ltd. In exchange X
Ltd. gives its intellectual property right to Y Ltd. Current market value of the patent
and intellectual property rights are ` 20,00,000 and ` 18,00,000 respectively. At what
value patent right should be initially recognised in the books of X Ltd. in following two
situations?
158 IND AS-38: INTANGIBLE ASSETS

(a) X Ltd. did not pay any cash to Y Ltd.

(b) X Ltd. pays ` 2,00,000 to Y Ltd.

Q.11: X Garments Ltd. spent ` 1,00,00,000 towards promotions for a fashion show by
way of various on-road shows, contests etc.
After that event, it realised that the brand name of the entity got popular and resultantly,
subsequent sales have shown a significant improvement. It is further expected that this
hike will have an effect over the next 2-3 years.
How the entity should account for the above cost incurred on promoting such show?

Q.12: An entity is developing a new production process. During 20X1-20X2, expenditure

incurred was ` 1,000, of which ` 900 was incurred before March 1, 20X2 and ` 100 was
incurred between March 1, 20X2 and March 31, 20X2. The entity is able to demonstrate
that at March 1, 20X2, the production process met the criteria for recognition as an
intangible asset. The recoverable amount of the know-how embodied in the process
(including future cash outflows to complete the process before it is available for use) is
estimated to be ` 500.
During 20X2-20X3, expenditure incurred is ` 2,000. At the end of 20X3, the recoverable
amount of the know-how embodied in the process (including future cash outflows to complete
the process before it is available for use) is estimated to be ` 1,900.

Q.13: X Ltd. is engaged is developing computer software. The expenditures incurred by

X Ltd. in pursuance of its development of software is given below:

(a) Paid ` 2,00,000 towards salaries of the program designers.

(b) Incurred ` 5,00,000 towards other cost of completion of program design.
(c) Incurred ` 2,00,000 towards cost of coding and establishing technical feasibility.
(d) Paid ` 7,00,000 for other direct cost after establishment of technical feasibility.
(e) Incurred ` 2,00,000 towards other testing costs.
(f) Cost of producing product masters for training material is ` 3,00,000.
(g) A focus group of other software developers was invited to a conference for the
introduction of this new software. Cost of the conference aggregated to ` 70,000.
(h) On March 15, 20X0, the development phase was completed and a cash flow budget was
prepared.
Net profit for the year was estimated to be equal ` 40,00,000. How X Ltd. should account
for the above mentioned cost?
 IND AS-38: INTANGIBLE ASSETS 159

Q.14: X Ltd. has started developing a new production process in financial year 20X1-20X2.
Total expenditure incurred till September 30, 20X3, was `1,00,00,000 . The expenditure
on the development of the production process meets the recognition criteria on July 1,
20X1. The records of X Ltd. show that, out of total ` 1,00,00,000, ` 70,00,000 were
incurred during July to September 20X1. X Ltd. publishes its financial results quarterly.
How X Ltd. should account for the development expenditure?

Q.15: X Ltd. decides to revalue its intangible assets on April 1, 20X1. On the date
of revaluation, the intangible assets stand at a cost of ` 1,00,00,000 and accumulated
amortisation is ` 40,00,000. The intangible assets are revalued at ` 1,50,00,000. How
should X Ltd. account for the revalued intangible assets in its books of account?
 160 IND AS-38: INTANGIBLE ASSETS

PAST EXAMINATION QUESTIONS

QUESTION 1 MAY 2019 EXAM

CARP Ltd. is engaged in developing computer software. The expenditures incurred by

CARP Ltd. in pursuance of its development of software is given below:

(i) Paid ` 1,50,000 towards salaries of the program designers.

(ii) Incurred ` 3,00,00 0 towards other cost of completion of program design.
(iii) Incurred ` 80,000 towards cost of coding and establishing technical feasibility.
(iv) Paid ` 3,00,000 for other direct cost after establishment of technical feasibility.

(v) Incurred ` 90,000 towards other testing costs.

(vi) A focus group of other software develop was was invited to a conference for the
introduction of this new software. Cost of the conference aggregated to ` 60,000.
(vii) On March 15, 2018, the development phase was completed and a cash flow budget
was prepared.
Net profit for the year 2017-18 was estimated to be equal ` 30,00,000.

How CARP Ltd. should account for the above mentioned cost as per relevant Ind AS?

ANSWER
Costs incurred in creating computer software, should be charged to research & development
expenses when incurred until technical feasibility/asset recognition criteria have been
established for the product. Here, technical feasibility is established after completion of
detailed program design.

In this case, ` 5,30,000 (salary cost of ` 1,50,000, program design cost of ` 3,00,000 and
coding and technical feasibility cost of ` 80,000) would be recorded as expense in Profit
and Loss since it belongs to research phase.

Cost incurred from the point of technical feasibility are capitalised as software costs.
But the conference cost of ` 60,000 would be expensed off.

In this situation, direct cost after establishment of technical feasibility of ` 3,00,000

and testing cost of ` 90,000 will be capitalised.

The cost of software capitalised is = ` (3,00,000 + 90,000) = ` 3,90,000.

 IND AS 40: INVESTMENT PROPERTY 161

IND AS 40: INVESTMENT PROPERTY

CONCEPT 1:BASIC KNOWLEDGE
A real estate property that has been purchased with the intention of earning return on the
investment (purchase) either through rent (income), the future resale of the property or
both. An investment property is like any other investment, the goal is to generate a profit.
In real estate, this is achieved through income (rent, for example) or through a profitable
resale. The way in which a property is used has a significant impact on its value. Investors
sometimes conduct studies to determine the best and most profitable use of a property.
This is often referred to as its highest to as its highest and best use.

CONCEPT 2: COVERAGE
This standard prescribes criteria for the accounting treatment for, and disclosures relating
to, investment property. The Standard shall be applied in the recognition, measurement,
and disclosure of investment property.

▪ The standard applies to the measurement in a lessee’s financial statements of investment

property held under a finance lease and to the measurement in the lessor’s financial
statements of investment property leased out under an operating lease.
▪ However this Standard does not apply
▪ To the matter covered in Ind AS-17, Leases.
▪ To biological assets related to agricultural activity (IndAS-41) or,
▪ To mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative
resources.

CONCEPT 3: CLASSIFICATION OF PROPERTY

1. Investment property – Land or building, or part of a building, or both, held by the owner
or the lessee under a finance lease to earn rentals and/or for capital appreciation,
rather than for:
▪ Use in production or supply of goods and services or
▪ Use in administrative purposes or
▪ Sale in the ordinary course of business.
2. Owner-occupied property – Property held by the owner or the lessee under a finance
lease for use in production or supply of goods and services or for administrative
purposes.
One of the distinguishing characteristics of investment property (compared to owner-
occupied property) is that it generates cash flows that are largely independent from
 162 IND AS 40: INVESTMENT PROPERTY

other assets held by an entity. Owner-occupied property is accounted for under Ind
AS-16, Property, plant, and Equipment.
In some instances, an entity occupies part of a property and leases out the balance. If
the two portions can be sold separately, each is accounted for appropriately. If the
portions cannot be sold separately, then the entire property is treated as investment
property only if an insignificant proportion is owner-occupied.
An issue arises with groups of companies wherein one group company leases a property
to another. At group, or consolidation level, the property is owner-occupied. However, at
individual company level, the owning entity treats the building as investment property.
Appropriate consolidation adjustments would need to be made in the group accounts.

EXAMPLES OF INVESTMENT PROPERTIES

The following are examples of investment property:

▪ Land held for long-term capital appreciation rather than for short-term sale in the
ordinary course of business
▪ Land held for a currently undetermined future use. (If an entity has not determined that
it will use the land as owner-occupied property or for short-term sale in the ordinary
course of business, the land is regarded as held for capital appreciation.)
▪ A building owned by the entity (or held by the entity under a finance lease) and leased
out under one or more operating leases.
▪ A building that is vacant but is held to be leased out under one or more operating leases.
▪ Property that is being constructed or developed for future use as investment property.

The following are examples of items that are not investment property and are therefore
outside the scope of this Standard

▪ Property intended for sale in the ordinary course of business or in the process of
construction or development for such sale (Ind AS-2, Inventories), for example,
property acquired exclusively with a view to subsequent disposal in the near future or
for development and resale.
▪ Owner-occupied property (IndAS-16), including (among other things) property held
for future use as owner-occupied property, property held for future development and
subsequent use as owner-occupied property, property occupied by employees (whether
or not the employees pay rent at market rates) and owner-occupied property awaiting
disposal.
▪ Property that is leased to another entity under a finance lease.
 IND AS 40: INVESTMENT PROPERTY 163

CONCEPT 4: MIXED CASES OF PROPERTIES

CASE 1: PROPERTY USED IN BUSINESS AS WELL AS FOR RENTAL

Some properties comprise a portion that is held to earn rentals or for capital appreciation
and another portion that is held for use in the production or supply of goods or services
or for administrative purposes. If these portions could be sold separately (or leased
out separately under a finance lease), an entity accounts for the portions separately. If
the portions could not be sold separately, the property is investment property only if an
insignificant portion is held for use in the production or supply of goods or services or for
administrative purposes.

CASE 2: PROPERTY ON THE BASIS OF ANCILLARY SERVICES

In some cases, an entity provides ancillary services to the occupants of a property it holds.
An entity treats such a property as investment property if the services are significant to
the arrangement as a whole. An example is when the owner of an office building provides
security and maintenance services to the lessees who occupy the building.

▪ In other cases, the services provided are significant. For example, if an entity owns
and manages a hotel, services provided to guests are significant to the arrangement as
a whole. Therefore, an owner-managed hotel is owner-occupied property, rather than
investment property.
▪ It may be difficult to determine whether ancillary services are so significant that a
property does not qualify as investment property. For example, the owner of a hotel
sometimes transfers some responsibilities to third parties under a management contract.
▪ The terms of such contracts vary widely. At one end of the spectrum, the owner’s
position may, in substance, be that of a passive investor. At the other end of the
spectrum, the owner’s may simply have outsourced day-to-day functions while retaining
significant exposure to variation in the cash flows generated by the operations of the
hotel.
▪ Judgment is needed to determine whether a property qualifies as investment property. An
entity develops criteria so that it can exercise that judgment consistently in accordance
with the definition of investment property requires an entity to disclose these criteria
when classification is difficult.

CASE 3: TREATMENT OF PROPERTY IN CONSOLIDATED STATEMENTS

In some cases, an entity owns property that is leased to, and occupied by, its parent or
another subsidiary. The property does not qualify as investment property in the consolidated
financial statements, because the property is owner-occupied from the perspective of the
group.
164 IND AS 40: INVESTMENT PROPERTY

However, from the perspective of the entity that owns it, the property is investment
property if it meets the definition of investment property. Therefore, the lessor treats
the property as investment property in its individual financial statements.

CONCEPT 5: RECOGNITION
Investment property shall be recognized as an asset when and only when:

▪ It is probable that future economic benefits will flow to the entity; and
▪ The cost of the investment property can be measured reliably.

CONCEPT 6: INITIAL MEASUREMENT

An investment property shall be measured initially at its cost, including transaction
charges.

CASE 1: PURCHASE BY CASH

The cost of a purchased investment property comprises its purchase price and any
directly attributable expenditure. Directly attributable expenditure includes for example,
professional fees for legal services, property transfer taxes and other transaction costs.
However cost of an investment property does not include:
▪ Start-up costs (unless they are necessary to bring the property to the condition
necessary for it to be capable of operating in the manner intended by management),
▪ Operating losses incurred before the investment property achieves the planned level of
occupancy, or
▪ Abnormal amounts of wasted material, labour or other resources in constructing or
developing the property
▪ Interest cost in case of deferred payment – If payment for an investment property is
deferred, its cost is the cash price equivalent. The difference between this amount and
the total payments is recognized as interest expense over the period of credit

CASE 2: INVESTMENT PROPERTY ACQUIRED IN EXCHANGE

One or more investment properties may be acquired in exchange for a non-monetary asset
or assets, or a combination of monetary and non-monetary assets. The cost of such an
investment property is measured at fair value unless:

▪ The exchange transaction lacks commercial substance; or

▪ The fair value of neither the asset received nor the asset given up is reliably measurable.

If the acquired asset is not measured at fair value, its cost is measured at the carrying
amount of the asset given up.
 IND AS 40: INVESTMENT PROPERTY 165

CASE 3: PURCHASE ON LEASE

However, property held under a finance lease shall be measured initially using the principles
contained in Ind AS-17, Leases – at the lower of the fair value and the present value of the
minimum lease payments. A key matter here is that the item accounted for at fair value is
not the property itself but the lease interest.

CONCEPT 7: MEASUREMENT AFTER RECOGNITION

An entity shall also measure subsequently after initial recognition all its investment property
at cost. In other words, the investment properties shall be carried in the balance sheet at
its cost less any accumulated depreciation and any accumulated impairment losses.
This Standard requires all entities to measure the fair value of investment property, for
the purpose of disclosure even though they are required to follow the cost model. An
entity is encouraged, but not required, to measure the fair value of investment property
on the basis of a valuation by an independent valuer who holds a recognised and relevant
professional qualification and has recent experience in the location and category of the
investment property being valued.
The investment property which meets the criteria to be classified as held for sale (or
are included in a disposal group that is classified as held for sale) in accordance with Ind
AS-105, Non-current Assets Held for Sale and Discontinued Operations such Investment
properties shall be measured in accordance with Ind AS-105.

CONCEPT 8: TRANSFERS
Transfers to, or from, investment property shall be made when, and only when, there is a
change in use, evidenced by;

▪ Commencement of owner-occupation, for a transfer from investment property to owner-

occupied property;
▪ Commencement of development with a view to sale, for a transfer from investment
property to inventories;
▪ End of owner-occupation, for a transfer from owner-occupied property to investment
property;
▪ Commencement of an operating lease to another party, for a transfer from inventories
to investment property.

Transfers between investment property, owner-occupied property and inventories do not

change the carrying amount of the property transferred and they do not change the cost
of that property for measurement or disclosure purposes.
 166 IND AS 40: INVESTMENT PROPERTY

CONCEPT 9: DISPOSAL
An investment property shall be derecognized on disposal or at the time that no benefit
is expected from future use or disposal. Any gain or loss is determined as the difference
between the net disposal proceeds and the carrying amount and is recognized in the income
statement.

CONCEPT 10: DISCLOSURE

▪ Classification criteria (to distinguish owner-occupied investment property, property

held for sale in situations where classification is difficult).
▪ Methods and assumptions used to determine fair value.
▪ Extent of involvement of independent used to determine fair value.
▪ Extent of involvement of independent, professional and recently experienced valuers in
the determination of fair value (whether used as measurement basis or disclosed)
Amounts included in profit or losses for:
• Rental income
• Direct operating expenses from rented property
• Direct operating expenses from non-rented property
▪ Restrictions on realisability or property or remittance of income/disposal proceeds
▪ Material contractual obligation:
• To purchase, construct or develop investment property; or
• For repair, maintenance or enhancements
▪ Depreciation method used
▪ Useful lives or depression rates used
▪ Gross carrying amount, accumulated depreciation and impairment losses at beginning and
end of period
▪ Reconciliation of brought forward and carried forward amounts.
▪ The fair value of investment property (or an explanation why it cannot be determined).
 IND AS 40: INVESTMENT PROPERTY 167

  QUESTION 1

Sun Ltd owns a building having 15 floors of which it uses 5 floors for its office; the
remaining 10 floors are leased out to tenants under operating leases. According to law
company could sell legal title to the 10 floors while retaining legal title to the other 5
floors.

SOLUTION
In the given scenario, the remaining 10 floors should be classified as investment property,
since they are able to split the title between the floors.

  QUESTION 2

Moon ltd uses 35% of the office floor space of the building as its head office. It leases
the remaining 65% to tenants, but it is unable to sell the tenant’s space or to enter into
finance leases related solely to it.

SOLUTION
Therefore, the company should not classify the property as an investment property as the
35% of the floor space used by the company is significant.

  QUESTION 3

An entity owns a hotel, which includes a health and fitness centre, housed in a separate
building that is part of the premises of the entire hotel. The owner operates the hotel
and other facilities on the hotel with the exception of the health and fitness centre,
which can be sold or leased out under a finance lease. The health and fitness centre will
be leased to an independent operator. The entity has no further involvement in the health
and fitness centre.

SOLUTION
In this scenario, management should classify the hotel and other facilities as property
plant and equipment and the health and fitness centre as investment property.
If the health and fitness centre could not be sold or leased out separately on a finance
lease, then because the owner-occupied portion is not insignificant, the whole property
would be treated as an owner-occupied property.

  QUESTION 4

The owner of an office building provides security and maintenance services to the lessees
who occupy the building.
168 IND AS 40: INVESTMENT PROPERTY

SOLUTION
In such a case, since the services provided are insignificant, the property would be treated
as an investment property.

  QUESTION 5

If an entity owns and manages a hotel, services provided to guests are significant to the
arrangement as a whole.

SOLUTION
In such case, an owner-managed hotel is owner-occupied property, rather than investment
property.

  QUESTION 6

Classify the following cases of given properties & tell which ind as should be applied on
these properties:

Summarisation

S.No. Property Does it meet Which Ind AS

definition of is Applicable
Investment
Property
1. Owned by a Co and leased out under an
Operating Lease
2. Held Under Finance Lease and Leased out under
an Operating Lease
3. Held under Finance Lease and Leased out
under Finance Lease
4. Property acquired with a view for development
and resale
5. Property developed on behalf of 3rd party
6. Property partly owner occupied and partly
leased out under Operating Lease
7. Land held for currently undetermined
use
8. Property occupied by Employees paying rent at
less than market rate
 IND AS 40: INVESTMENT PROPERTY 169

9. Investment Property held for sale

10. Existing Investment Property that is being
redeveloped for continued use as Investment
Property.

  QUESTION 7

X Limited owns a building which is used to earn rentals. The building has a carrying amount
of ` 50,00,000. X Limited recently replaced interior walls of the building and the cost of
new interior walls is ` 5,00,000. The original walls have a carrying amount of ` 1,00,000.
How X Limited should account for the above costs?

SOLUTION
Under the recognition principle, an entity recognises in the carrying amount of an investment
property the cost of replacing part of an existing investment property at the time that
cost is incurred if the recognition criteria are met and the carrying amount of those parts
that are replaced is derecognised.
So, X Limited should add the cost of new walls and remove the carrying amount of old
walls. The new carrying amount of the building = ` 50,00,000 + ` 5,00,000 – ` 1,00,000 =
` 54,00,000.

  QUESTION 8

Sun Ltd acquired a building in exchange of a warehouse whose fair value is `

5,00,000 and payment of cash is ` 2,00,000. The fair value of the building received by
the Company is ` 8,00,000.

SOLUTION
The company decided to keep that building for rental purposes. The Building is acquired
with the purpose to earn rentals. Hence, it is a case of Investment.
Property acquired in exchange for a combination of monetary and non-monetary asset.
Therefore
Journal entry at the time of acquisition is:

Investment Property (Building) .Dr 8,00,000

To Cash 2,00,000
To PPE (Property Plant and Equipment) i.e. Warehouse 5,00,000
To Gain on exchange (Profit or Loss) 1,00,000
170 IND AS 40: INVESTMENT PROPERTY

  QUESTION 9

X Limited purchased a building for ` 30,00,000 in May 1, 20X1.The purchase price was
funded by a loan. Property transfer taxes and direct legal costs of ` 1,00,000 and `
20,000 respectively were incurred in acquiring the building. In 20X1-20X2, X Limited
redeveloped the building into retail shops for rent under operating leases to independent
third parties. Expenditures on redevelopment were:
` 2,00,000 planning permission.
` 7,00,000 construction costs (including ` 40,000 refundable purchases taxes).
The redevelopment was completed and the retail shops were ready for rental on
September 2, 20X1. What is the cost of building at initial recognition?

SOLUTION
The cost of a purchased investment property comprises its purchase price and any direct
attributable expenditure.
So, the cost of the building = ` (30,00,000 +1,00,000 + 20,000 + 2,00,000 + 7,00,000 -
40,000) = ` 39,80,000.

  QUESTION 10

X Limited purchased a land worth of ` 1,00,00,000. It has option either to pay full amount
at the time of purchases or pay for it over two years for a total cost of ` 1,20,00,000.
What should be the cost of the building under both the payments method?

SOLUTION
Using either payment method, the cost will be ` 1,00,00,00. If the second payment option
is used, ` 20,00,000 will be treated as interest expenses over the period of credit i.e.,
2 years.

  QUESTION 11

X Limited (as the lessee) has taken a building under finance lease from the owner. It
classifies its interest in the leasehold building as investment property and after initial
recognition measures the property interest at fair value. The present value of the
minimum lease payment is ` 40,000. At what value, X Limited will recognise its investment
property?

SOLUTION
X Limited shall initially recognise the property interest at ` 40,000. A corresponding lease
liability of ` 40,000 will be recognised as follows:
 IND AS 40: INVESTMENT PROPERTY 171

Investment Property A/c Dr. ` 40,000

To Finance lease obligation ` 40,000.

  QUESTION 12

Moon Ltd has purchased a building on 1st April 20X1 at a cost of ` 10 million. The building
was used as a factory by the Moon Ltd and was measured under cost model. The expected
useful life of the building is estimated to be 10 years. Due to decline in demand of the
product, the Company does not need the factory anymore and has rented out the building
to a third party from 1st April 20X5. On this date the fair value of the building is ` 8 million.
Moon ltd uses cost model for accounting of its investment property.

  QUESTION 13

On April 1, 20X1 an entity acquired an investment property (building) for ` 40,00,000.

Management estimates the useful life of the building as 20 years measured from the date
of acquisition. The residual value of the building is ` 2,00,000. Management believes that
the straight-line depreciation method reflects the pattern in which it expects to consume
the building’s future economic benefits. What is the carrying amount of the building on
March 31, 20X2?

  QUESTION 14

X Limited has an investment property (building) which is carried in Balance Sheet on March
31, 20X1 at ` 15,00,000. During the year X Limited has stopped letting out the building and
used it as its office premise. On March 31, 20X1, management estimates the recoverable
amount of the building as ` 10,00,000 and its remaining useful life as 20 years and residual
value is nil. How should X Limited account for the above investment property as on March
31, 20X1?

  QUESTION 15

In financial year 20X1-20X2, X Limited incurred the following expenditure in acquiring

property consisting of 6 identical houses each with separate legal title including the land
on which it is built.
The expenditure incurred on various dates is given below:
On April 1, 20X1 - Purchase cost of the property ` 1,80,00,000.
On April 1, 20X1 – Non-refundable transfer taxes ` 20,00,000 (not included in the purchase
cost).
On April 2, 20X1- Legal cost related to property acquisition ` 5,00,000. On April 6, 20X1-
Advertisement campaign to attract tenants ` 3,00,000.
172 IND AS 40: INVESTMENT PROPERTY

On April 8, 20X1 - Opening ceremony function for starting business ` 1,50,000.

Throughout 20X1-20X2, incurred ` 1,00,000 towards day-to-day repair maintenance and
other administrative expenses.
X Limited uses one of the six houses for office and accommodation of its few staffs. The
other five houses are rented to various independent third parties.
How X Limited will account for all the above mentioned expenses in the books of account?

  QUESTION 16

S1 Ltd. lets out a property to S2 Ltd. under operating lease both the companies are
subsidiary of P Ltd.
Analyse how would different companies treat the property in their respective separate
financial statements and consolidated financial statements.

  QUESTION 17

S1 Ltd lets out a property to S2 Ltd. under finance lease.

Both the companies are subsidiary of P Ltd.
S2 Ltd. sub-let out a portion of the property to K Ltd. under operating lease.
Analyse how different companies would treat the property in their respective separate
financial statements and consolidated financial statements.

  QUESTION 18

[Acquisition of investment property on deferred payments basis]

X Ltd. acquired an investment property under defer payment plan Down payment on date
of acquisition ` 50,00,000
After 6 months ` 120,00,000
After 1 year ` 5, 00,00,000
The incremental borrowing rate of the company is 11%. Find out cost of investment property
at initial recognition? How should X Ltd. account for the difference?

  QUESTION 19

[Component-wise depreciation of investment property]

X Ltd. acquired and land for ` 15 cr. And constructed buildings at a cost of ` 40 cr. To
be used for letting out for commercial and residential purposes under varied lease terms.
Interior walls in the common spaces were decorated at a cost of ` 120 lakhs. The useful
life of the building is estimated at 50 years and that of interior decoration 15 years. After
 IND AS 40: INVESTMENT PROPERTY 173

10 years, the entity changed the interior decoration at a cost of ` 1.50 cr. And estimated
new useful life of 15 years.
Find out depreciation charge during 1-11 years and show accounting entry for the replacement
of interior walls.

  QUESTION 20

The fair value of an investment property at the beginning of the year 2015-16 is € 25
million and at end of 2015-16 is € 25 million.
There is an air-conditioning plant which was purchased at the beginning of 2013-14 for € 1
million. It is depreciated @ 10% p.a. and lift installed at the beginning of 2011-12 costing
€ 1.2 million which is also depreciated @ 10% p.a. As per Paragraph 50 of Ind AS 40, the
company wishes to present an all-inclusive fair value of investment property. Assume that
depreciated book value of equipment represents the fair value at the end of the year.
The company is in a dilemma about the procedure to be followed for fair value measurement.

  QUESTION 21

X Ltd. has the following four properties:

(i) Property A used as office building of the company – Cost ` 30 cr. Accumulated
depreciation ` 20 cr., Net ` 10 cr.
The company puts the property into renovation and intended to lease out under one or
more operating leases.
(ii) Property B used under operating leases –Cost ` 50 cr. Accumulated depreciation ` 20
cr. Net ` 30 cr.dd
The property is put into renovation for sale.
(iii) Property C used under operating leases – Cost ` 40 cr. accumulated depreciation ` 20
cr., Net ` 20 cr.
The property is put into sale.
(iv) Property D used under operating lease – Cost ` 40 cr. accumulated depreciation ` 20
cr., Net ` 20 cr.
The property is put into renovation and intended to be used as office building after
the renovation.
How should the transfer be evidenced? How would these transfers change the classification
of the respective property?
174 IND AS 40: INVESTMENT PROPERTY

SELF PRACTICE QUESTIONS

Q1: K Ltd is a supplier of industrial products. In 2013, the company purchased a plot of
lands on the outskirts of a major city. The area has mainly low-cost public housing and
very limited public transport facilities. The government has plans to develop the area as
an industrial park in 5 years times and the land is expected to greatly appreciate in value
if the government process with the plan. K Ltd’s management classifies such a property
that is held for undermined future use?
Solution: Management should classify the property as an investment property. Although
management has not determined a use for the property after the parks’ development takes
place, in the medium-term the land is held for capital appreciation. Standard considers land
as held for capital appreciation, if K Ltd has not determined that it will use the land either
as owner-occupied property or for short-term sale in the ordinary course of business.

Q2: M. Ltd owns a hotel resort, which includes a casino, housed in a separate building that
is part of the premises of the entire hotel resort. Its patrons would be largely limited to
tourists and non-resident visitors only.
Solution: The owner operates the hotel and other facilities on the hotel resort, with the
exception of the casino, which can be sold or leased out under a finance lease. The casino
will be leased to an independent operator. M Ltd has no further involvement in the casino.
The casino operator will not be prepared to operate it without the existence of the hotel
and other facilities.
In this scenario, management should classify the hotel and other facilities as property,
plant and equipment and the casino as investment property. As explained in Ind AS-40, the
casino can be sold separately or leased out under finance lease.

Q3: K Ltd owns a hotel, B Ltd, a fellow subsidiary of K Ltd manages a chain of hotels, and
receives management fees for operating its chains, except for the hotel owned by K Ltd.
K Ltd’s owned hotel is leased to B Ltd for ` 20,00,000 a month for a period of 5 years.
Any profit or losses from operating K Ltd’s hotel rests with B Ltd the hotel that K Ltd
owns has an estimated remaining useful life of 4 years.
Solution: In the consolidated financial statement, the hotel should be classified as property,
plant and equipment. This is because it is both owned and managed by the group from the
perspective for the group and therefore, it should be recognized as owner-occupied for the
use in the supply of goods or services.
 IND AS 40: INVESTMENT PROPERTY 175

Q4: An investment property company has been constructing a new cinema as 31st December
2016, the cinema was nearing completion and the costs incurred to date were:

Material, labour and sub-contractors 148 lakhs

Other directly attributable overheads 25 lakhs
Interest on borrowings 13 lakhs

In is company’s policy to capitalize interest on specific borrowing raised for the purpose
of financing a construction. The amount of borrowings outstanding at 31st December 2016
in respect of this project is ` 180 lakhs and annual interest rate is 9.5%.
During the 3 months to 31st March 2017 the cinema was completed, with the following
additional costs incurred.
Material, labour and sub-contractors 17 lakhs
Other overheads 3 lakhs
The company was not able to determine the fair value of the property reliably the
construction period and so valued it at cost pending completion (as allowed Ind AS-40).
On 31st March 2010, the company obtained a professional appraisal of the cinema’s fair
value and the valuer concluded that it was worth ` 240 lakhs. The fee for this appraisal
was ` 1 lakh and has not been included in the above figures for costs incurred during the
3 months.
The cinema was taken by a notional multiplex chain on an operating lease as at 1st April
2017 and was immediately welcoming capacity crowds. Following a complete valuation of
the company’s investment properties at 31st December 2017, the fair value of the cinema
was established at ` 280 lakhs.
Required: Set out the accounting entries in respect of the cinema complex for the year
ended 31st December 2017
Solution: On 1st January 2010 the property would have been valued at its cost of
` 186 lakhs as the fair value was not determinable during the period for construction.
Costs incurred in the 3 months to 31st March 2010

Asset under construction Dr. 17 lakhs

To Cash/ Payable 17 lakhs
Asset under construction Dr. 3 lakhs
To Cash/ Payable 3 lakhs
Asset under construction Dr. 4.30 lakhs
To Interest Expense 4.30 lakhs
176 IND AS 40: INVESTMENT PROPERTY

Working
Outstanding borrowing: ` 180 lakhs
Interest for 3 months: ` 180 lakhs x 3/12 x 9.5% = ` 430,000
Accumulated costs at the date of transfer into investment properties
Cost to 31st December 2009 (148+25+13+) 186.00
Cost to 31st March 2010 (17+3+4.3) 24.30
210.30
Fair value of the investment property as on 31st March 2017 and 31st Dec 2017 would be
disclosed in the financial statement for these period as per Ind AS-40. Fees paid to the
valuer of ` 1 lakhs will be expensed in Profit or loss.

Q5: Phoenix Mills Ltd, a listed company in India ventured into construction of a mega
shopping mall in India, which is rated as the largest shopping mall of India. The company’s
board of directors after market research decided that instead of selling the shopping mall
to a local investor, who had approached them several times during the construction period
with excellent affairs which he progressively increased ruing the year of construction,
the company would hold this property for the purposes of earning rentals by letting out
space in the shopping mall to tenants. For this purpose it used the service of a real estate
company to find an anchor tenant (a major international retail chain) that then attracted
other important retailers locally to rent space in the mega shopping mall, and within
months of the completion of the construction the shopping mall was fully let out.
The construction of the shopping mall was completed and the property was placed in
service at the end of 2016. According to the company’s engineering department the
computed total cost of the construction of the shopping mall was ` 100 core.
The independent valuation expert was of the opinion that the useful life of the shopping
mall was 10 years and its residual value was ` 10 core.
What would be the impact on the profit and loss account of the company under the Cost
Model?
Solution: Under the cost model Company would have to provide depreciation over 10 years
and also to provide impairment losses if any. The asset should be carried at its cost less
accumulated depreciation and any accumulated impairment losses. The annual depreciation
which is computed based on the acquisition cost of the investment property will be the only
charge to the net profit or loss for each period (unless there is impairment which will also
be a charge to the net profit or loss for the year).
Based on the acquisition cost of ` 100 Crores (assuming there is no subsequent expenditure
that would be capitalized), a residual value of ` 10 crores, a useful life of 10 years, and using
the straight-line method of depreciation, the annual impact of depreciation on the Net
 IND AS 40: INVESTMENT PROPERTY 177

profit or loss for each year would be ` (100-10)/10 Crore = 9 Crore besides this the annual
rent will be shown as an income in the Statement of Profit and loss.

SHORT QUESTIONS FOR CROSS CHECKING OF GRIP ON TOPIC

Q1: An investment property should be measured initially at
(a) Cost
(b) Cost less accumulated impairment losses
(c) Depreciable cost less accumulated impairment losses
(d) Fair value less accumulated impairment losses
Answer: (a)

Q2: The applicable IFRS/IAS for PPE being constructed or developed for future use as
investment property is
(a) IAS 2, Inventories, until construction is complete and then it is accounted for
under IAS 40, Investment Property.
(b) IAS 40, Investment Property.
(c) IAS 11, Construction Contracts, until construction is complete and then it is
accounted for under IAS 40, Investment Property.
(d) IAS 16, Property, Plant, and Equipment, until construction is complete and then it
is accounted for under IAS 40, Investment Property.
Answer: (d)

Q3: In case of property held under an operating lease and classified as investment
property
(a) The entity has to account for the investment property under the cost model only.
(b) The entity has to use the fair value model only.
(c) The entity has the choice between the cost model and the fair value model.
(d) The entity needs only to disclose the fair value and can use the cot model under Ind
AS-40.
Answer: (d)

Q4: Transfer from investment property to property plant, and equipment are appropriate
(a) When there is change of use.
(b) Based on the entity’s discretion
178 IND AS 40: INVESTMENT PROPERTY

(c) Only when the entity adopts the fair value model under Ind AS-40.
(d) The entity can never transfer property into another classification on the balance
sheet once it is classified as investment property.
Answer: (a)

Q.5: An investment property is derecognized (eliminated from the balance sheet) when
(a) It is disposed to a third party.
(b) It is permanently withdrawn from use.
(c) No future economic benefits are expected from its disposal.
(d) In all of the above cases.
Answer: (d)
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 179

IND AS 105: NON-CURRENT ASSETS HELD

FOR SALE AND DISCONTINUED OPERATIONS

UNIT 1: ASSETS HELD FOR SALE

CONCEPT 1: OBJECTIVE

• Non-Current assets held for sale are presented separately from other assets in the
Balance Sheet as their classification will change and the value will be principally recovered
through sale transaction rather than through continuous use in operations of the entity.
This standard specifies the accounting for assets held for sale.
• Results of Discontinuing Operations should be separately presented in the Statement
of Profit and loss as it affects the ability of the entity to generate future cash flows.
This standard specifies the presentation and disclosure of discontinued operations.
Hence, two core objectives of the standard is as follows:

Presentation and
Accounting for Assets
Disclosure of
held for sale
Discontinued Operations

Measured at Fair Results to be presented

Value less Cost to sell; separately in the
Depreciation on such Statement of Profit &
assets to cease Loss

Presented separately in
the Balance Sheet

CONCEPT 2: SCOPE

• The classification and presentation requirements of this Ind AS apply to all recognised
non-current assets and to all disposal groups of an entity.
• The measurement requirements of this Ind AS also apply to all recognised non-current
assets and to all disposal groups of an entity except few exceptions mentioned below.
180 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

• Assets classified as non-current in accordance with Ind AS 1, Presentation of Financial

Statements, shall not be reclassified as current assets until they meet the criteria to
be classified as held for sale in accordance with this Ind AS.
• The classification, presentation and measurement requirements in this Ind AS applicable
to a non-current asset (or disposal group) that is classified as held for sale apply also
to a non-current asset (or disposal group) that is classified as held for distribution to
owners acting in their capacity as owners.
• The measurement provisions of this Ind AS do not apply to the following assets (which
are covered by the Ind ASs listed either as individual assets or as part of a disposal
group):

Measurement Provisions of Ind AS 105 do not apply

Assets Financial Contractual

Deferred arising from Assets Non-current Non-current rights under
tax Assets Employee Assets Assets Insurance
benefits Within the contracts
scope of Ind
AS 109

Which are Which are

measured at measured at Fair
As defined in
Ind AS 12 Ind AS 19 Fair value less value less costs to
Ind AS 104
cost to sell in sell in accordance
Ind AS 41 with Ind AS 41

CONCEPT 3: RELEVANT DEFINITIONS

The following are the key terms used in this standard:

• Non-current assets are assets that do not meet the definition of current assets.
• Current asset An entity classifies an asset as current when:
(a)
it expects to realise the asset, or intends to sell or consume it, in its normal
operating cycle;
(b)
it holds the asset primarily for the purpose of trading;
(c)
it expects to realise the asset within twelve months after the reporting period;
or
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 181

(d)
the asset is cash or a cash equivalent (as defined in Ind AS 7) unless the asset is
restricted from being exchanged or used to settle a liability for at least twelve
months after the reporting period.
• Disposal group is a group of assets to be disposed of, by sale or otherwise, together
as a group in a single transaction, and liabilities directly associated with those assets
that will be transferred in the transaction. A disposal group may be a group of cash-
generating units, a single cash-generating unit, or part of a cash-generating unit.
• Cash-generating unit is a smallest identifiable group of assets that generates cash
inflows that are largely independent of the cash inflows from other assets or groups
of assets.
• Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date. (Ind AS 113)
• Costs to sell are the incremental costs directly attributable to the disposal of an
asset (or disposal group), excluding finance costs and income tax expense.
• A discontinued operation is a component of an entity that either has been disposed of
or is classified as held for sale and:
represents a separate major line of business or geographical area of operations;
(a)
or
is part of a single co-ordinated plan to dispose of a separate major line of business
(b)
or geographical area of operations; or
(c) is a subsidiary acquired exclusively with a view to resale.
• A component of an entity comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest of the
entity.
• Highly Probable Significantly more likely than probable. (Probable means more likely
than not)

CONCEPT 4: CLASSIFICATION OF NON-CURRENT ASSETS

(OR DISPOSAL GROUPS) AS HELD FOR SALE OR
AS HELD FOR DISTRIBUTION TO OWNERS
An entity is required to classify a non-current asset (or disposal group) as held for sale
if its carrying amount will be recovered principally through a sale transaction rather than
through continuing use.
 182 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

Available for Immediate

Sale in present condition

Key requirements for Non-current

Assets asset held for sale
Available for Immediate
Sale in present condition

Asset must be available for immediate sale in its present condition and Sale must be highly
probable are the two key requirements to classify a non-current asset as held for sale.
Available for Immediate Sale
The asset (or disposal group) must be available for immediate sale in its present condition.
The terms that are usual and customary for sale of similar assets (or disposal group) doesn’t
disqualify to being classified as held for sale.
However they will not be considered as available for immediate sale if they continue to be
vital for the entity’s ongoing operations or being refurbished to enhance their value. Thus,
an asset (or disposal group) cannot be classified as a non-current asset (or disposal group)
held for sale, if the entity intends to sell it in a distant future.

Examples – Available for Immediate Sale

1. A property being held by the entity needs to be vacated before it can be sold. The
time required to vacate the building is usual and customary for sale of such assets.
Hence the criteria for classification as held for sale would be met.
2. In above example, if property can be vacated only after a replacement is available
then this may indicate that the property is not available for immediate sale, but only
after the replacement becomes available.
3. An entity can’t classify a manufacturing facility as held for sale if prior to selling the
facility it needs to clear a backlog of uncompleted order.
4. In above example, if entity intends to sell the manufacturing facility along with the
uncompleted orders it can be classified as held for sale.
5. An entity plans to renovate some of its property to increase its value prior to selling it
to a third party. The entity is already searching for a buyer at current market values.
But due to the plans to renovate the property prior to sale. The property may not be
meeting condition of available for immediate sale.
6. A company has put a property on the market and expects that all the conditions
of classification as held for sale is meeting. Any buyer will undertake searches and
valuations before making an offer and exchanging contracts : Such conditions are
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 183

normal for properties and any delays that might arise from such legal processes do not
preclude the property from being classified as held for sale.

Sale must be highly probable

This Standard defines ‘highly probable’ as ‘significantly more likely than probable’ where
probable means more likely than not.
Ind AS 105 prescribes following five conditions to be satisfied for the sale to qualify as
highly probable :

1. The appropriate level of management must be committed to a plan to sell the asset
(or disposal group).
2. An active programme to trace a buyer and complete the selling plan must have been
initiated.
3. The asset (or disposal group) must be marketed for sale at a price that is reasonable
in relation to its current fair value.
4. The sale transaction is expected to be completed within one year from the date of
classification.
5. Significant changes to or withdrawal from the plan to sell the asset are unlikely.

EXAMPLE
An entity is committed to its selling plan of a manufacturing facility in its present condition
and so classifies it as held for sale. After a firm purchase commitment, the buyer’s inspection
identifies environmental damages not previously known to exist. The entity is required
by the buyer to make good the damage, which will extend the timeframe of one year to
complete the sale within one year. However the entity has initiated actions to make good
the damage and satisfactory rectification is highly probable. In this situation exception to
one year requirement will met.

Sale includes exchange

Sale transaction includes exchange of non-current assets for other non-current assets
when the exchange has commercial substance in accordance of Ind AS 16 Property, Plant
and Equipment.

Asset acquired exclusively with a view to subsequent disposal

When an entity acquires a non-current asset (or disposal group) exclusively with a view to
its subsequent disposal, the non-current asset (or disposal group) is classified as held for
sale at the acquisition date. This standard provides a short period (usually three months)
184 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

to meet the classification criteria that don’t met at the acquisition except requirement of
one year.

Example:
An entity has acquired a building exclusively with a view of its subsequent disposal. The
management is highly confident that the property can be sold in one year. The property
requires refurbishing it to enhance its value which is highly probable to be completed in less
than a period of three months. The building will be classified as held for sale on the date of
acquisition itself even though it is not immediately available for sale.

CONCEPT 5: MEASUREMENT OF NON-CURRENT ASSETS

(OR DISPOSAL GROUPS) CLASSIFIED AS HELD FOR SALE

Measurement at the lower of carrying amount and fair value less cost to sell

• An entity should measure a non-current asset (or disposal group) classified as held for
sale at the lower of its carrying amount and fair value less costs to sell.
• If a newly acquired asset (or disposal group) meets the criteria to be classified as held
for sale, it will be measured on initial recognition at the lower of its carrying amount
had it not been so classified (for example, cost) and fair value less costs to sell. Hence,
if the asset (or disposal group) is acquired as part of a business combination, it will be
measured at fair value less costs to sell.
• Immediately before the initial classification of the asset (or disposal group) as held
for sale, the carrying amounts of the asset (or all the assets and liabilities in the group)
is measured in accordance with applicable Ind AS.
• On subsequent remeasurement of a disposal group, the carrying amounts of any assets
and liabilities that are not within the scope of the measurement requirements of this Ind
AS, but are included in a disposal group classified as held for sale, should be remeasured
in accordance with applicable Ind Ass before the fair value less costs to sell of the
disposal group is remeasured.
• Depreciation and amortization shall be immediately stopped from the moment the asset
has been classified as held for sale.
• Interest and other expenses attributable to the liabilities of a disposal group classified
as held for sale shall continue to be recognised.
• When the sale is expected to occur beyond one year, the entity should measure the
costs to sell at their present value. Any increase in the present value of the costs to sell
that arises from the passage of time shall be presented in profit or loss as a financing
cost.
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 185

• Non-current asset (or disposal group) classified as held for distribution are also measured
on same line as non-current asset (or disposal group) classified as held for sale.

  QUESTION 1
Measurement prior to classification as held for sale
An item of property, plant and equipment that is measured on the cost basis should be
measured in accordance with Ind AS 16.
Entity ABC owns an item of property and it was stated at the following amounts in its last
financial statements:
31st December 20X1

Cost 12,00,000
Depreciation (6,00,000)
Net book value 6,00,000

The asset is depreciated at an annual rate of 10% (1,20,000)

During July 20X2 entity ABC decides to sell the asset and on 1st August it meets the
conditions to be classified as held for sale. Analyse.

SOLUTION
At 31st July entity ABC should ensure that the asset is measured in accordance with Ind AS
16. It should be depreciated by a further 70,000 (7 months × 10,000) and should be carried
at 5,30,000 before it is measured in accordance with Ind AS 105.
Note: From the date the asset is classified as held for sale no further depreciation will be
charged.

Example - Classification as held for sale

A ltd acquired a property for ` 2,00,000. After few years the cumulative depreciation on
the property is of ` 80,000 has been recognised and subsequently the property is classified
as held for sale under Ind AS 105.
At the time of classification as held for sale it will be measured at lower of its carrying
amount which is ` 1,20,000 (2,00,000 – 80,000) and fair value less costs to sell as estimated
at ` 1,00,000.
Accordingly, there is a write-down on initial classification of property as held for sale and
accordingly the property is carried at ` 1,00,000. A loss of `20,000 is recognised in profit
or loss.
 186 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

On next reporting date, the property’s fair value less costs to sell is estimated at ` 85,000.
Accordingly, a loss of ` 15,000 is recognised in profit or loss and the property is carried at
` 85,000.
Subsequently, the property is sold for ` 90,000. A gain of ` 5,000 is recognised.

Recognition of impairment losses and reversals

• An entity should recognise an impairment loss for any initial or subsequent write-down
of the asset (or disposal group) to fair value less costs to sell, to the extent that it has
not been recognised in accordance with above.
• An entity should recognise a gain for any subsequent increase in fair value less costs
to sell of an asset, but not in excess of the cumulative impairment loss that has been
recognised either in accordance with this Ind AS or previously in accordance with Ind
AS 36, Impairment of Assets.
• An entity should recognise a gain for any subsequent increase in fair value less costs to
sell of a disposal group:
to the extent that it has not been recognised in the remeasurement of scoped
(a)
out non-current assets, current assets and liablities; but
not in excess of the cumulative impairment loss that has been recognised, either
(b)
in accordance with this Ind AS or previously in accordance with Ind AS 36, on the
non-current assets that are within the scope of the measurement requirements
of this Ind AS.
• The impairment loss (or any subsequent gain) recognised for a disposal group should
reduce (or increase) the carrying amount of the non-current assets in the group that
are within the scope of the measurement requirements of this Ind AS, in the order of
allocation set out in paragraphs 104(a) and (b) and 122 of Ind AS 36 .
As per Para 104 (a) and (b) of Ind AS 36, Impairment of Assets, The impairment loss
shall be allocated to disposal groups in the following order:
(i) first, to reduce the carrying amount of any goodwill allocated to the disposal
group; and
(ii) then to the other assets of the disposal group pro rata on the basis of the carrying
amount of each asset in the group.
• A gain or loss not previously recognised through remeasurement by the date of the
sale of a noncurrent asset (or disposal group) should be recognised at the date of
derecognition.
Requirements relating to derecognition are set out in:

(a) paragraphs 67–72 of Ind AS 16 for property, plant and equipment; and
(b) paragraphs 112–117 of Ind AS 38, Intangible Assets, for intangible assets.
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 187

  QUESTION 2

Disposal Group Carrying amount at the Carrying amount as

reporting date before remeasured immediately
classification as held for before classification as held
sale for sale
Goodwill 1,500 1,500
Property, Plant and Equipment 4600 4000
(carried at revalued amounts)
Building (carried at cost) 5,700 5,700
Inventory 2,400 2,200
Investment in Equity Instruments 1,800 1,500
Total 16,000 14,900

The entity estimated that fair value less costs to sell of the disposal group amounts to `
13,000.
Suppose, at the end of reporting period the fair value less cost to sell is increased and
estimated at ` 15,500.

CONCEPT 6: PRESENTATION AND DISCLOSURES OF

A NON-CURRENT ASSET (OR DISPOSAL GROUP)
CLASSIFIED AS HELD FOR SALE

Non – current assets and disposal groups classified as held for sale
Entity shall present and disclose information about non - current asset (or disposal group)
classified as held for sale in such a manner that enable the user of financial statements
to evaluate financial effects of non-current asset (or disposal group) classified as held for
sale.

Presentation

• An entity is required to present a non-current asset classified as held for sale and the
assets of a disposal group classified as held for sale separately from other assets in the
balance sheet.
• The liabilities of a disposal group classified as held for sale should be presented
separately from other liabilities in the balance sheet. Those assets and liabilities should
not be offset and presented as a single amount.
188 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

• The major classes of assets and liabilities classified as held for sale should be separately
disclosed either in the balance sheet or in the notes, except when the disposal group is
a newly acquired subsidiary that meets the criteria to be classified as held for sale on
acquisition.
• An entity should present separately any cumulative income or expense recognised in
other comprehensive income relating to a non-current asset (or disposal group) classified
as held for sale.
• If the disposal group is a newly acquired subsidiary that meets the criteria to be
classified as held for sale on acquisition, disclosure of the major classes of assets and
liabilities is not required.
• Comparative amounts for non-current assets or for the assets and liabilities of disposal
groups classified as held for sale in the balance sheets for prior periods are not
reclassified or re-presented to reflect the classification in the balance sheet for the
latest period presented.
• Any gain or loss on the remeasurement of a non-current asset (or disposal group)
classified as held for sale that does not meet the definition of a discontinued operation
shall be included in profit or loss from continuing operations.

Example: Presentation of Disposal group

Property, Plant and Equipment 4,900

Inventory 1,700
Investment in equity instruments 1,400
Liabilities (3,300)
Net Carrying Amount 4,700

An amount of ` 400 relating to these assets has been recognised in other comprehensive
income and accumulated in equity.
The presentation of disposal group in entity’s Balance Sheet is as follows:

Assets 20X1-20X2 20X2-20X3

Non –Current Assets X X
AAA X X
BBB X X
CCC X X
X X
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 189

Current Assets
DDD X X
EEE X X
X X
Non-Current Assets Classified as Held for Sale 8,000 -
X X
Total Assets X X
Equity and Liabilities
Equity attributable to equity holders of the parent
FFF X X
GGG X X
Amounts recognised in other comprehensive income and 400 -
accumulated in equity relating to non-current assets held
for sale
X X
Non-Controlling Interests X X
Total Equity X X

Non-Current Liabilities
HHH X X
III X X
X X
Current Liabilities
KKK X X
LLL X X
MMM X X
Liabilities directly associated with non-current 3,300 -
assets classified as held for sale
X X
Total liabilities X X
Total Equity and liabilities X X
 190 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

CONCEPT 7: DISCLOSURES

• An entity should disclose the following information in the notes to the financial statements
in the period in which a non-current asset (or disposal group) has been either classified
as held for sale or sold:
(a) Description of the non-current asset (or disposal group);
(b) Description of facts and circumstances of the sale, or leading to the expected
disposal and the expected manner and timing of that disposal;
(c) Gain or loss recognised and if not presented separately on the face of the income
statement, the caption in the income statement that includes that gain or loss.
(d) If applicable, the reportable segment in which the non-current asset (or disposal
group) is presented in accordance of Ind AS 108 Operating Segments.
(e) If there is a change of plan to sell, a description of facts and circumstances
leading to the decision and its effect on results.

  QUESTION 3

S Ltd purchased a property for ` 6,00,000 on 1 April 20X1. The useful life of the property
is 15 years. On 31 March 20X3 S ltd classify the property as held for sale. The impairment
testing provides the estimated recoverable amount of ` 4,70,000.
The fair value less cost to sell on 31 March 20X3 was ` 4,60,000. On 31 March 20X4
management change the plan as property no longer met the criteria of held for sale. The
recoverable amount as at 31 March 20X4 is ` 5,00,000.
Value the property at the end of 20X3 and 20X4.
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 191

UNIT 2: DISCONTINUED OPERATIONS

Discontinued operation – definition

• Ind AS 105 defines Discontinued Operation as: A component of an entity that either has
been disposed of or is classified as held for sale and:
(a) represents a separate major line of business or geographical area of operations;
or
(b) is part of a single co-ordinated plan to dispose of a separate major line of business
or geographical area of operations; or
(c) is a subsidiary acquired exclusively with a view to resale.
• A component of an entity comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest of the
entity. In other words, a component of an entity will have been a cash-generating unit or
a group of cash-generating units while being held for use.

  QUESTION 4

Sun Ltd is a retailer of takeaway food like burger and pizzas. It decides to sell one of its
outlets located in chandni chowk in New Delhi. The company will continue to run 200 other
outlets in New Delhi.
All Ind AS 105 criteria for held for sale classification were first met at 1st October 20X1.
The outlet will be sold in June 20X2.
Management believes that outlet is a discontinued operation and wants to present the
results of outlet as ‘discontinued operations’. Analysis

SOLUTION
The chandani chowk outlet is a disposal group; it is not a discontinued operation as it is only
one outlet. It is not a major line of business or geographical area, nor a subsidiary acquired
with a view to resale.

Separate presentation of discontinued operations

An entity should present and disclose information that enables users of the financial
statements to evaluate the financial effects of discontinued operations and disposals of
non-current assets (or disposal groups).
This allows the user to distinguish between the operations which will continue in the future
and those which will not and make it more predictable the ability of entity to generate
future cash flows.
192 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

Presentation in the statement of profit and loss

An entity shall disclose a single amount in the statement of profit and loss comprising the
total of:

(a) the post-tax profit or loss of discontinued operations; and

(b) the post-tax gain or loss recognised on the measurement to fair value less costs to
sell or on the disposal of the assets or disposal group(s) constituting the discontinued
operation.

In addition, this single amount must be analysed into:

(a) the revenue, expenses and pre-tax profit or loss of discontinued operations;
(b) the related income tax expense as required by paragraph 81(h) of Ind AS12;
(c) the gain or loss recognised on the measurement to fair value less costs to sell or on the
disposal of the assets or disposal group(s) constituting the discontinued operation; and
(d) the related income tax expense as required by paragraph 81(h) of Ind AS12.

• The analysis may be presented in the notes or in the statement of profit and loss. If it is
presented in the statement of profit and loss it should be presented in a section identified
as relating to discontinued operations, i.e. separately from continuing operations. The
analysis is not required for disposal groups that are newly acquired subsidiaries that
meet the criteria to be classified as held for sale on acquisition.
• Entities are required to disclose the amount of income from continuing operations and
from discontinued operations attributable to owners of the parent. These disclosures
may be presented either in the notes or in the statement of profit and loss.

Disclosures in the statement of cash flows

The net cash flows attributable to the operating, investing and financing activities of
discontinued operations. These disclosures may be presented either in the notes or in the
financial statements. These disclosures are not required for disposal groups that are newly
acquired subsidiaries that meet the criteria to be classified as held for sale on acquisition.
When the amounts relating to discontinued operations are presented separately, the
comparative figures for prior periods are also re -presented, so that the disclosures relate
to all operations that have been discontinued by the end of the reporting period for the
latest period presented.

Adjustment to prior period disposals

Adjustments in the current period to amounts previously presented in discontinued
operations that are directly related to the disposal of a discontinued operation in a prior
period should be classified separately in discontinued operations. The nature and amount
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 193

of such adjustments are disclosed. Examples of circumstances in which these adjustments

may arise include the following:

(a) the resolution of uncertainties that arise from the terms of the disposal transaction,
such as the resolution of purchase price adjustments and indemnification issues with
the purchaser;
(b) the resolution of uncertainties that arise from and are directly related to the
operations of the component before its disposal, such as environmental and product
warranty obligations retained by the seller; and
(c) the settlement of employee benefit plan obligations, provided that the settlement is
directly related to the disposal transaction.

Change to a plan of sale

If an entity ceases to classify a component of an entity as held for sale, the results of
operations of the component previously presented in discontinued operations should be
reclassified and included in income from continuing operations for all periods presented.
The amounts for prior periods should be described as having been re-presented.

Loss of Control in Subsidiary

An entity that is committed to a sale plan involving loss of control of a subsidiary should
disclose the information as above when the subsidiary is a disposal group that meets the
definition of a discontinued operation.

Example:
Presentation of Discontinued Operations in the Statement of profit and loss.
Statement of profit and loss for the year ended 31st March 20X3

20X1-20X2 20X2-20X3
Continuing Operations
Revenue XX XX
Cost of Sales (XX) (XX)
Gross Profit XX XX
Other Income XX XX
Distribution Costs (XX) (XX)
Administrative Expenses (XX) (XX)
Other Expenses (XX) (XX)
Finance Costs (XX) (XX)
194 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

Share of Profit of Associates XX XX

Profit before Tax XX XX
Income Tax Expense (XX) (XX)
Profit for the period from Continuing Operation XX XX
Discontinued Operations
Profit for the period from discontinued Operations* XX XX
Profit for the period XX XX
Attributable to:
Owner of the parent
Profit for the period from continuing operations XX XX
Profit for the period from discontinued operations XX XX
Profit for the period attributable to owners of the parent XX XX
Non-Controlling Interests
Profit for the period from continuing operations XX XX
Profit for the period from discontinued operations XX XX
Profit for the period attributable to non-controlling interests XX XX
XX XX

Note (a) the required analysis would be given in the notes

  QUESTION 5

On November 30, 20X1, Entity X becomes committed to a plan to sell a property. However,
it plans certain renovations to increase its value prior to selling it. The renovations are
expected to be completed within a short span of time i.e., 2 months.
Can the property be classified as held for sale at the reporting date i.e. December 31,
20X1?

  QUESTION 6

On March 1, 20X1, entity R decides to sell one of its factories. An agent is appointed and
the factory is actively marketed. As on March 31, 20X1, it is expected that the factory
will be sold by February 28, 20X2. However, in May 20X1, the market price of the factory
deteriorated. Entity R believed that the market will recover and thus did not reduce the
price of the factory. The company’s accounts are authorised for issue on June 26, 20X1.
Should the factory be shown as held for sale as on March 31, 20X1?
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 195

  QUESTION 7

On June 1, 20X1, entity X plans to sell a group of assets and liabilities, which is classified as
a disposal group. On July 31, 20X1, the Board of Directors approves and becomes committed
to the plan to sell the manufacturing unit by entering into a firm purchase commitment with
entity Y. However, since the manufacturing unit is regulated, the approval from the regulator
is needed for sale. The approval from the regulator is customary and highly probable to
be received by November 30, 20X1 and the sale is expected to be completed by March 31,
20X2. Entity X follows December year end. The assets and liabilities attributable to this
manufacturing unit are as under:
Amount (in `)

Particular Carrying value as on Carrying value as on

December 31, 20X0 July 31, 20X1
Goodwill 500 500
Plant and Machinery 1,000 900
Building 2,000 1,850
Debtors 850 1,050
Inventory 700 400
Creditors (300) (250)
Loans (2,000) (1,850)
2,750 2,600

The fair value of the manufacturing unit as on December 31, 20X0 is `2,000 and as on July
31, 20X1 is ` 1,850. The cost to sell is 100 on both these dates. The disposal group is not
sold at the period end i.e., December 31, 20X1. The fair value as on December 31, 20X1 is
lower than the carrying value of the disposal group as on that date.
Required:

1. Assess whether the manufacturing unit can be classified as held for sale and reasons
there for. If yes, then at which date?
2. The measurement of the manufacturing unit as on the date of classification as held
for sale.
3. The measurement of the manufacturing unit as at the end of the year.
196 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

PAST EXAMINATION QUESTIONS

QUESTION 1 NOVEMBER 2018 EXAM

PB Limited purchased a plastic bottle manufacturing plant for ` 24 lakh on 1st April, 2015.
The useful life of the plant is 8 years. On 30th September. 2017, PB Limited temporarily
stops using the manufacturing plant because demand has declined. However, the plant is
maintained in a workable condition and it will be used in future when demand picks up.
The accountant of PB Limited decide to treat the plant as held for sale until the demand
picks up and accordingly measures the plant at lower of carrying amount and fair value less
cost to sell. The accountant has also stopped charging depreciation for rest of the period
considering the plant as held for sale. The fair value less cost to sell on 30Th September,
2017 and 31St March, 2018 was ` 13.5 lakh and ` 12 lakh respectively.
The accountant has made the following working:

Carrying amount on initial classification as held for sale ` `

Purchase price of Plant 24,00,000  

Less: Accumulated Depreciation [(` 24,00,000/8)]x2.5 years] 7,50,000 16,50,000

Fair value less cost to sell as on 31st March, 2017   12,00,000

The value lower of the above two 12,00,000

Balance Sheet extracts as on 31st March, 2018

Particulars `
Assets  
Current Assets  
Other Current Assets  

Assets classified as held for sale 12,00,000

Required:
Analyze whether the above accounting treatment is in compliance with the Ind AS. If not,
advise the current treatment showing necessary workings.

ANSWER
As per Ind AS 105’ Non-current Assets Held for Sale and Discontinued Operations’, an
entity shall classify a non-current asset as held for sale if its carrying amount will be
recovered principally through a sale transaction rather than through continuing use.
For asset to be classified as held for sale, it must be available for immediate sale in its
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 197

present condition subject only to terms that are usual are customary for sales of such
assets and its sale must be highly probable. In such a situation, an asset cannot be classified
as a non-current asset held for sale, if the etity intends to sell it in a distant future.
For the sale to be highly probable, the appropriate level of management must be committed
to a plan to sell the asset, and an active programme to locate a buyer and complete the
plan must have been initiated. Further, the asset must be actively marketed for sale at
price that is reasonable in relation to its current fair value. In addition, the sale should be
expected to qualify for recognition as a completed sale within one year from the date of
classification and actions required to complete the plant should indicate that it is unlikely
that significant changes to the plan will be made or that the plan will be withdrawn.
Further Ind AS 105 also states that an entity shall not classify as held for sale a non –
current asset that is to be abandoned. This is because its carrying amount will be recovered
principally through continuing use.
An entity shall not account for a non-current asset that has been temporarily taken out of
use as if it had been abandoned.
In addition to Ind AS 105, Ind AS 16 states that depreciation does not cease when the
asset becomes idle or is retired from active us unless the asset is fully depreciated.
The Accountant of PB Ltd. has treated the plant as held for sale and measured it at the
fair value less cost to sell. Also, the depreciation has not been charged thereon since the
date of classification as held for sale which is not correct and not in accordance with Ind
AS 105 and Ind AS 16.
Accordingly, the manufacturing plant should neither be treated as abandoned asset nor as
held for sale because its carrying amount will be principally recovered through continuous
use. PB Ltd shall not stop charging depreciation on treat the plant as held for because its
carrying amount will be recovered principally through continuing use to the end of their
economic life.
The working of the same for presenting in the balance sheet will be as follows:
Calculation of carrying amount as on 31st March,2018 `
Purchase Price of Plant 24,00,000
Less: Accumulated depreciation (24,00,000/ 8 years) x 3 years -9,00,000
Carrying amount before impairment 15,00,000
Less: Impairment loss (Refer Working Note) -3,00,000
Revised carrying amount after impairment 12,00,000
198 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

Balance Sheet extracts as on 31st March 2018

Assets `
Non-Current Assets
Property, Plant and Equipment 12,00,000
Working Note:
Fair value less cost to sell of the Plat = ` 12,00,000
Value in Use (not given) or = Nil (since plant has temporarily not been used for manufacturing
due to decline in demand)
Recoverable amount= higher of above i.e. ` 12,00,000
Impairment loss = Carrying amount – Recoverable amount
Impairment loss = ` 15,00,000 = ` 12,00,000
= ` 3,00,000

QUESTION 2 NOVEMBER 2019 EXAM

On June 1, 2018, entity D Limited plans to sell a group of assets and liabilities, which
is classified as a disposal group. On July 31, 2018, the Board of Directors approved and
committed to the plan to sell the manufacturing unit by entering into a firm purchase
commitment with entity G Limited.
However, since the manufacturing unit is regulated, the approval from the regulator is
needed for sale. The approval from the regulator is customary and highly probable to be
received by November 30, 2018 and the sale is expected to be completed by
31st March, 2019. Entity D Limited follows December year end. The assets and liabilities
attributable to this manufacturing unit are as under:
(` In lakh)
Particulars Carrying value as on 31st Carrying value as on
December, 2017 31st July, 2018
Goodwill 1,000 1,000
Plant and Machinery 2,000 1,800
Building 4,000 3,700
Debtors 1,700 2,100
Inventory 1,400 800
Creditors (600) (500)
Loans (4,000) (3,700)
Net 5,500 5,200
The fair value of the manufacturing unit as on December 31, 2017 is ` 4,000 lakh and as
on July 31, 2018 is ` 3,700 lakh. The cost to sell is ` 200 lakh on both these dates. The
disposal group is not sold at, the period end i.e., December 31, 2018. The fair value as on
 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS 199

31st December, 2018 is lower than the carrying value of the disposal group as on that date.
Required:
i) Assess whether the manufacturing unit can be classified as held for sale and reasons
thereof. If yes, then at which date?
ii) The measurement of the manufacturing unit as on the date of classification as held
for sale.
iii) The measurement of the manufacturing unit as at the end of the year.

ANSWER
(i) Assessment of manufacturing unit whether to be classified as held for sale
The manufacturing unit can be classified as held for sale due to the following reasons:
(a) The disposal group is available for immediate sale and in its present condition.
The regulatory approval is customary and it is expected to be received in one
year. The date at which the disposal group is classified as held for sale will be
31st July, 2018, i.e. the date at which management becomes committed to the
plan.
(b) The sale is highly probable as the appropriate level of management i.e., board
of directors in this case have approved the plan.
(c) A firm purchase agreement has been entered with the buyer.
(d) The sale is expected to be complete by 31st March, 2019, i.e., within one year
from the date of classification.
(ii) Measurement of the manufacturing unit as on the date of classification as held for
sale
Following steps need to be followed:
Step 1: Immediately before the initial classification of the asset (or disposal group) as
held for sale, the carrying amounts of the asset (or all the assets and liabilities in the
group) shall be measured in accordance with applicable Ind AS.
This has been done and the carrying value of the disposal group as on 31st July, 2018
is determined at ` 5,200 lakh. The difference between the carrying value as on 31st
December, 2017 and 31st July, 2018 is accounted for as per Ind AS 36.
Step 2: An entity shall measure a non-current asset (or disposal group) classified as held
for sale at the lower of its carrying amount and fair value less costs to sell.
The fair value less cost to sell of the disposal group as on 31st July, 2018 is `
3,500 lakh (i.e .` 3,700 lakh - ` 200 lakh). This is lower than the carrying value of ` 5,200
lakh. Thus, an impairment loss needs to be recognised and allocated first towards goodwill
and thereafter pro-rata between assets of the disposal group which are within the scope
of Ind AS 105 based on their carrying value.
200 IND AS 105: NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

Thus, the assets will be measured as under:

(` In lakh)

Carrying value
Carrying value – as per Ind AS
Particulars Impairment
31st July, 2018 105 – 31st July,
2018
Goodwill 1,000 -1,000  
    (Refer WN)  
Plant and Machinery
1,800 -229 -1,571
Building
Debtors 3,700 (Refer WN)  
Inventory 2,100 -471 3,229
Creditors 800 - 2,100
Loans -500 - 800
  -3,700 - -500
  5,200 -3,700
    -1,700 3,500
Working Note:

Allocation of impairment loss to Plant and Machinery and Building

After adjustment of impairment loss of ` 1,000 lakh from the full value of goodwill, the
balance ` 700 lakh (` 1,700 lakh – ` 1,000 lakh) is allocated to plant and machinery and
Building on proportionate basis.
Plant and machinery – ` 700 lakh x ` 1,800 lakh / ` 5,500 lakh = ` 230 lakh (rounded off)
Building – ` 700 lakh x ` 3,700 lakh / ` 5,500 lakh = ` 470 lakh (rounded off)
1. Measurement of the manufacturing unit as on the date of classification as at the year
end
2. The measurement as at the year-end shall be on similar lines as done above.
 INDIAN ACCOUNTING STANDARD 116: LEASES 201

INDIAN ACCOUNTING STANDARD 116: LEASES

CONCEPT 1: APPLICATION & OBJECTIVE

Ministry of Corporate Affairs (MCA) has notified new standard on leases i.e Ind AS 116
vide its notification dated 30th March, 2019. Lease accounting has undergone significant
changes on introduction of Ind AS 116 which is fully converged With IFRS 16. This new
standard replaced the erstwhile Ind AS 17 and is effective from financial periods beginning
on or after 1stApril, 2019
Ind AS 17 was based on dual classification model of operating and finance leases with
different classification and measurement guidance for each of team. The dual classification
model did not account for the assets and liabilities associated with the rights and obligations
that arise out of the most “operating leases.
Ind AS 116, Leases, requires most leases to be recognised on the balance sheet and
requires enhanced disclosers. It is believed that will result in more faithful representation
of leases. Assets and liabilities and greater transparency about the lessee’s obligations
and leasing activities However, Ind AS 116 does not make fundamental changes to existing
lessor accounting model.
The objective of this standard is to ensure that lessees and lessors provide relevant
information in a manner that faithfully represents those transactions. This information
gives a basis for users of financial statements to assess the effect that leases have on
the financial position, financial performance and cash flows of an entity, This standard
requires an entity to consider the terms and conditions of contracts and relevant facts
and circumstances, and to apply the standard consistently to contracts with similar
characteristics and in similar circumstances.

CONCEPT 2: ASSETS OUT OF SCOPE

Ind AS 116 shall be applied to ALL LEASES EXCEPT for:

Sr. No. Particulars Reason

1 Leases to explore for or use Within the scope of Ind AS 106
minerals oil, natural gas and similar ‘Exploration for and Evaluation of
non- regenerative resources Mineral Resources
2 Leases of biological assets held by Within the scope of Ind AS 41’
a lessee Agriculture’
3 Service concession arrangements Within the scope of Appendix D of Ind
AS 115 ‘ Revenue from Contracts with
Customers’
202 INDIAN ACCOUNTING STANDARD 116: LEASES

4 Licences of intellectual property Within the scope of Ind AS 115 Revenue

granted by a lessor from Contracts with Customers’

5 Rights held by a lessee under Within the scope of Ind AS 38 ‘

licensing agreements for such Intangible Assets’
items as motion picture films, video
recordings, plays, manuscripts,
patents and copyrights

CONCEPT 3: EXPEMTIONS UNDER IND AS 116

In addition to above scope exclusions, a lessee can elect not to apply Ind AS 116’s recognition
requirements to :

1. Short-term leases; and

2. Leases for which the underlying asset is of low-value
If a lessee elects to apply the above recognition exemption, the lessee shall recognise the
lease payments associated with those leases a an expense on either a straight- line basis
over the lease them or another systematic basis, if that basis is more representative of
the pattern of the lessee’s benefit.

A. SHORT TERM LEASE

A short-term lease is a lease that, at the commencement date, has a lease term of 12
months or less and does not included an option to purchase the underlying asset.

As the determination is made at the commencement date, a lease cannot be classified as

short-term if the lease term is subsequently reduced to lease than 12 months.

GROUP OF ASSETS
The short-term lease exemption can be made by class of underlying asset to which the
right of use related. A class of underlying asset is a grouping of underlying assets of a
similar nature and use in an entity’s operations.

 EXAMPLE

An entity which has leased several items of office equipment – some of them for them
than 12 months and some for more than 12 months, with none containing purchase options.
Assuming that the items of office equipment are all considered to be the same class, if
the entity wished to use the short term lease exemption it must apply that exemption for
all of the leases with terms of 12 months or less. The leases with terms longer than 12
 INDIAN ACCOUNTING STANDARD 116: LEASES 203

months will be accounted for in accordance with the general recognition and measurement
requirements for lessees.
A lessee that makes this election must make certain quantitative and qualitative disclosures
about short-term leases. Once a lessee establishes a policy for a class of underlying assets,
all further short- term leases for that class requires to be accounted for in accordance
with the lessee’s policy.

  QUESTION 1 SHORT- TERM LEASE

Scenario A:
A lessee enters into a lease with a nine- month non- cancellable term with an option to
extend the lease for four months. The lease does not have a purchase option. At the lease
commencement date, the lessee is reasonably certain to exercise the extension option
because the monthly lease Payment during the extension period are significantly below
market rates. Whether the lessee can take a short-term exemption in accordance with
IndAS 116?

Scenario B:
Assume the same facts as Scenario A except, at the lease commencement, date the lessee
is not reasonably certain to exercise the extension option because the monthly lease
payments during the optional extension period are at what the lease expects to be market
rates and there are no other factors that would make exercise of the renewal option
reasonably certain. Will your answer be different in this case?

SOLUTION
Scenario A:
As the lease is reasonably certain to exercise the extension option (Refer section 3.2 lease
them), the lease term is greater than 12 months (i.e., 13 months) therefore, the lease will
not account for the lease as a short- term lease.

Scenario B:
In this case, the lease term is less than 12 months, i.e., nine months, thus, the lessee may
account for the said lease under the short-term lease exemption, i.e., it recognises lease
payments as an expense on either a straight-line basis over the lease term or another
systematic basis.
204 INDIAN ACCOUNTING STANDARD 116: LEASES

B. LOW VALUE ASSETS

Lessees can also make an election for leases for which the underlying asset is of low value
(i.e. low- value assets).
Though Ind AS 116 does not explicitly define the leases of low-value assets, it provides the
conditions based on which an asset can be treated as of low-value and the said exemption
can be availed accordingly for such low- value asset (s). Following are the conditions:

An underlying asset can be of low value ONLY IF

BOTH the following conditions are satisfied:

The lessee can benefit from use of The underlying asset is not highly dependent
the underlying asset on its own on, or highly interrelated with other assets

 EXAMPLE

1. An entity may lease a car for use in the business and the lease included the use of
the tyres attached to the car. To use the tyres for their intended purpose, they
can only be used with the car and as such, they are depended on, or highly
interrelated with car. Therefore, the tyres would not qualify for the low- value
asset exemption.
2. An entity enters into a rental contract for a large number of laptops. Each laptop
within the contract constitutes an identified asset. Entity has considered that the
value of individual laptop would be low, even though the contract for all the laptops
is not. The conditions of Ind AS 116 are satisfied i.e. the entity can benefit from
use of an individual laptop together with other resources that are already available
and each laptop does not need other assets to make it functional. Consequently, each
laptop qualifies as al low value asset and the entity can elect to apply the low-value
exemption to all laptops under the contract.
The exemption for leases of low- value items intends to capture leases that are high
in volume but low in value – e.g. leases of small IT equipment (laptops, mobile phones,
simple printers), leases of office furniture etc. Ind AS 116 is silent on any threshold
to determine the value for classifying any asset as low value assets.
 INDIAN ACCOUNTING STANDARD 116: LEASES 205

The following boxes depicts the important points regarding the leases of low-value assets:

Value of an underlying asset to be Leases of low-value assets are

assessed based on the value of the asset exempted regardless of whether
when it is new, regardless of the *age of those leases are material to the
the asset being leased lessee

Examples of low-value underlying assets can include:

- Tablet
- Personal computers,
- Small items of office furniture
- telephones

*A lease of an underlying asset does not qualify as a lease of low value asset if the nature
of the asset is such that, when new, the asset is typically not of lows value, for e.g., leases
of cars would not qualify as leases of low –value assets because a new car would typically
not be of low value.

CONCEPT 4: MEANING OF LEASE

At the inception of a contract, an entity shall assess whether the contract is or contains a
lease. For the purpose, a lease is defined as a contract, or part of a contract that conveys
the right to control the use of an identified asset for a period of time in exchange for
consideration.
Ind AS 116 requires customers and suppliers to determine whether a contract is or contains
a lease at the inception of the contract.

The inception date is defined as the earlier of the following dates:

Date of a lease agreement
Date of commitment by the parties to the principal terms and conditions of the lease

A period of time may be described in terms of the amount of use of an identified asset
(for e.g. the number of production units an item of equipment will be used to product). It
includes any non-consecutive periods of time.
206 INDIAN ACCOUNTING STANDARD 116: LEASES

CONCEPT 5: WHETHER AN AGREEMENT CONTAINS LEASE

(VERY IMPORTANT)

No Is there an identified asset?

Yes

Does the customer have right to

obtain substantially all of the economic No
benefits from the use of asset
throughout the period of use?

Yes

Does the customer, the supplier or

Customer neither party have the right to direct Supplier
how and for what purpose the asset is
used throughout the period of use?

Yes

If Predetermined then whether the

customer
Operates the asset?
OR
Designed the asset?

Yes

Contract Contract does not

Contains a lease contains a lease

PART 1: IDENTIFIED ASSET

An Arrangement only contains a lease if there is f identified asset under Ind as 116,
an identified asset can be explicitly specified in a contract or implicitly
specified at the time that the asset is made available for use by the customer.
 INDIAN ACCOUNTING STANDARD 116: LEASES 207

  QUESTION 2

Asset implicitly specified in a contract

Customer XYZ enters into a ten- year contract with Supplier ABC for the use of rolling
stock specifically designed for Customer XYZ.
The rolling stock is designed to transport materials used in Customer XYZ’s production
process and is not suitable for use by other customers. The rolling stock is not explicitly
specified in the contract gut, Supplier ABC owns only one rolling stock that is suitable
for Customer XYZ’s use. If the rolling does not operate properly, the contract requires
Supplier ABC to repair or replace the rolling stock.
Whether there is an identified asset?

SOLUTION
Yes, the said rolling stock is an identified asset.
Through the rolling stock is not explicitly specified in the contract (e.g., by serial number),
it is implicitly specified because suppler ABC must use it to fulfil the contract.

  QUESTION 3

Asset implicitly specified in a contract

Customer XYZ enters into a ten-year contract with Supplier ABC for the use of a car. The
specification of the car is specified in the contract (i.e., Brand, type, colour, options, etc.).
At inception of the contract, the car is not yet built.
Whether there is an identified Asset?

SOLUTION
Yes, the said car is an Identified asset.
Though the car cannot be identified at inception of the contract, it is implicitly specified
at the time the same will be made available to Customer XYZ.
208 INDIAN ACCOUNTING STANDARD 116: LEASES

NO LEASE EVEN IF THERE IS AN IDENTIFIED ASSET

CASE I: SUBSTANTIVE SUBSTITUTION RIGHTS

This is a very important concept since without evaluating this condition the condition, as
to whether there is identified asset cannot be attained. So, even if an asset is specified,
an customer dies not have not the use an identified asset if, an inception of the contract,
an supplier has the substantive right to substitute the asset throughout the period of use.
A supplier right to substitute an asset is SUBSTANTIVE when BOTH of the following
conditions are met:

The supplier has the PRACTICAL

ABILITY to substitute alternative assets
throughout the period of use (For e.g.
the customer cannot prevent the supplier
form substituting an asset and alternative
assets are readily available to the supplier
or could be sourced by the supplier within a
reasonable period of time).
Substantive
Substitution
Rights

The supplier would BENEFIT

ECONOMICALLY
From the exercise of its right to substitute
the asset (i.e. the economic benefits
associated with substituting the asset are
expected to exceed the costs associated
with substituting the asset)>

Further, if the supplier has a right or an obligation to substantive the asset only on or after
either a particular date, or the occurrence of a specified event the supplier’s substitution
right is not substantive because the supplier does not have the practical ability to
substitute alternative assets throughout the period of use.
An entity’s evaluation of whether a supplier’s substitution right is substantive is based on
facts and circumstances at inception of the contract. At inception of the contract, an
entity should not consider future events that are not likely to occur. Ind AS 116 provides
 INDIAN ACCOUNTING STANDARD 116: LEASES 209

the following examples of circumstances that, at inception of the contract, are not likely
to occur and, thus, are excluded from the evaluation of whether a supplier’ s substitution
right is substantive throughout the period of use:

(1) (2)
An agreement by a future customer The introduction of new technology
to pay an above market rate for use that is not substantially developed at
of the asset inception of the contract

(3)
A substantial difference between the
market price of the asset during the period
of use, and the market price considered
likely at inception of the contract

Ind AS 116 further clarifies that a customer should presume that a supplier’s substitution
right is not substantive when the customer cannot readily determine whether the supplier
has a substantive substitution right this requirement is intended to clarify that a customer
is not expected to exert undue effort to provide evidence that a substitution right is not
substantive. However, suppliers should have sufficient information to make a determination
of whether a substitution right is substantive .

  QUESTION 4

Substantive Substitution Rights

Scenario A:
A electronic data storage provider (suppler provides services through a centralised data
centre that involve the use of a specified server No. 10) The suppler maintains may identical
servers in a single accessible location and determines, at inception of the contract, that
is permitted to and can easily substitute another server without the customer’s consent
throughout the period of use.
Further, the suppler would benefit economically from substituting an alternative asset,
because doing this would allow the supplier to optimise the performance of its network at
only a nominal cost. In addition, the supplier has make clear that is has negotiated right of
substitution as an important rift in the arrangement, and the substitution right affected
the pricing of the arrangement.
Whether the substitution rights are substantive and whether there is an identified asset?
210 INDIAN ACCOUNTING STANDARD 116: LEASES

Scenario B:
Assume the same facts as in Scenario A expect that Server No. 10 is customised, and the
supplier does not have the practical ability to substitute the customised asset throughout
the period of use. Additionally, it is unclear whether the supplier would benefit economically
from sourcing a similar alternative asset.
Whether the substitution rights are substantive and whether there is an identified
asset?

SOLUTION
Scenario A:
The customer does not have the right to use an identified asset because, at the inception
of the contract the supplier has the practical ability to substitute the server and would
benefit economically form such a substitution. thus there is no identified asset.
However, if the customer could not readily determine whether the supplier had a substantive
substitution right (for e.g., there is insufficient transparency into the supplier’s operations),
the customer would presume the substitution right is not substantive and conclude that
there is an identified asset.

Scenario B:
The substitution right is not substantive, and Server No. 10. Would be an identified asset
because the supplier does not have the practical ability to substitute the asset and there
is no evidence to economic benefit to the supplier for substituting the asset. In this case,
neither of the conditions of a substitution right is met (whereas both the conditions must
be met for the supplier to have a substantive substitution right). Therefore, serve no 10
will be considered as an identified asset.

CASE II: IDENTIFIED ASSET – PHYSICALLY DISTINCT:

An identified asset must be physically distinct. A physically distinct asset may be an entire
asset or a portion of an asset. For example, a building is generally considered physically
distinct, but one floor within the building many also be considered physically distinct if it
can be used independent of the other floors.
The term “ substantially all is not defined in Ind AS 116.
This can be better understood with the help of the following illustrations:
 INDIAN ACCOUNTING STANDARD 116: LEASES 211

  QUESTION 5

Identified Asset –Physically Distinct):

Customer XYZ enters into a 15- year contract with supplier ABC for the right to use
five fibres within a fibre cable between Mumbai and Pune. The contract identifies
five of the cable’s 25 fibres for use by Customer XYZ. The five fibres dedicated
solely to Customer XYZ’s data for the duration of the contract team. Assume that
Supplier ABC does not have a substantive substitution right.
Whether there is an identified asset?

  QUESTION 6

(Identified Asset – Not physically Distinct):

Scenario A:
Customer XYZ enters into a ten-year contract with supplier ABC for the right to transport
oil from India to Bangladesh through Supplier ABC’s pipeline. The contract provides that
Customer XYZ will have the right of 95% of the pipeline s capacity throughout the team of
the arrangement.
Whether there is an identified asset.

Scenario B:
Assume the same facts as in Scenario A, except the Customer XYZ has the right to use
65% of the pipeline‘s capacity throughout the term arrangement
Whether there is an identified asset?

SOLUTION:
Scenario A:
Yes the capacity portion of the pipeline is an identified asset.
While 95% of the pipeline’s capacity is not physically distinct from the remaining capacity
of the pipeline, it represents substantially all of the capacity of the entire pipeline
and thereby provides Customer XYZ with right to obtain substantially all the economic
benefits from of the pipeline.

Scenario B:
No. The capacity portion of the pipeline is NOT an identified asset.
Since 65% XYZ does not have the right to obtain substantially all of the economic
benefits from use of the pipeline.
212 INDIAN ACCOUNTING STANDARD 116: LEASES

CONCEPT 6: RIGHT TO CONTROL

To assess whether a contract conveys the right to control the use of an identified asset for
a period of time, an entity shall assess whether, throughout the period of use, the customer
has both of the following:
(a) The right to obtain substantially all of the economic from use of the identified asset;
and
(b) The right to direct the use of the identified asset
The right to control the use of an asset may not necessarily be documented, in from, as a
lease agreement. Often, the right to use an identified asset is embedded in an arrangement
that many appear to be a supply arrangement or service contract. Therefore, a reporting
entity should consider all of the terms of an arrangement of determine whether it contains
a lease.

If the customer has the right to control the use of an identified asset for only a portion
of the term of the contract, the contract contains a lease for that portion of the term.

  QUESTION 7

(Right to use for a portion of the term of contract):

ABC Ltd enters into a contract with XYZ Ltd, which grants ABC Ltd exclusive rights to
use a specific grain facility over a five-year period in the months of May and June. During
these months ABC Ltd has the right to decide which crops are placed in storage and when
to remove them. XYZ Ltd provides the loading and unloading services for the warehouse
activities. During the other then months each year, XYZ Ltd has the right to determine how
the warehouse will be used.
Which party has the right to control the use of the identified asset during the period of
use?

SOLUTION:
In the above, ABC Ltd has the right to control the use the identified asset during the period
of use because they have the power to determine how the warehouse be used during the
contractually defined usage periods. The analysis should focus on the rights and economics
of the use of the warehouse for the specified usage period (May and June). During the
period of use, ABC Ltd has rights to determine how much of a crop to place in storage, and
the timing of placing and removing it from storage. These rights are more significant to
the economics of the use of the asset than the loading and unloading services performed
by XYZ Ltd during the same period. ABC Ltd receives all of the economic benefit from use
of the asset during those specified time period. Therefore, contract contains a lease for
the specified period of team.
 INDIAN ACCOUNTING STANDARD 116: LEASES 213

A. Right to Obtain Substantially All of the Economic Benefits

The first criterion in the control assessment is to determine whether the customer has the
right to obtain substantially all of the economic benefits from use of the asset throughout
the period of use (for e.g., by having exclusive use of the asset throughout that period).
A customer can obtain economic benefits either directly or indirectly for e.g., by using
holding or subleasing the asset). Economic benefits from use of an asset include:

♦ The asset’s primary outputs (i.e., goods or services )

♦ Any by – products (for e.g., renewable energy credits that are generated through the
use of the asset), including potential cash flows derived from these items.
♦ benefits from using the asset that could be realised from a commercial transaction with
a third party (For e.g., subleasing the asset)

POINTS WHICH DO NOT AFFECT CUSTOMER’ RIGHT

A Right that solely protects the supplier’s interest in the underlying asset (e.g., limits
on the number of miles a customer can drive a supplier’s vehicle) does not, in and of itself,
prevent the customer from obtaining substantially all of the economic benefits from use
of the asset and, therefore, are not considered when assessing whether a customer has
the right to obtain substantially all of the economic benefits.

If a contract requires a customer to pay the supplier or another party a portion of the
cash flows derived from the use of an asset as consideration (For e.g. if the customer is
required to pay the supplier a percentage of sales from use of retail space as consideration
for that use) that requirement does not prevent the customer from having the right to
obtain substantially all of the economic benefits from use of the retail space.

  QUESTION 8

(Right to obtain substantially all of the economic benefits):

Company MNO enters into a 15- year contract with power Company PQR purchase all of
the electricity produced by a new solar farm. PQR owns the solar farm and will receive tax
credits relating to the construction and ownership of the solar farm, and MNO will receive
renewable energy credits that accrue from use of the solar farm.)
Who has the right to substantial benefits from the solar farm?

SOLUTION
Company MNO has the right to obtain substantially all of the economic benefit from use of
the solar farm over the 15-yaer period because it obtains:
214 INDIAN ACCOUNTING STANDARD 116: LEASES

 The electricity produced by the farm over the lease term_ i.e. the primary product
from use of the asset; and
 the renewable energy credits_ i.e. the by product from use of the asset.
Although PQR receives economic benefits from the solar farm in the form of tax credits,
these economic benefits relate to the ownership of the solar farm. The taxcredits do not
relate to use of the soar farm therefore are not considered in this assessment.

B.Right to Direct the use of the identified Asset

The second criterion in the control assessment is to determine whether the customer
has the right to direct the use of the identified asset throughout the period of use.
Decisions about how and for what purpose an asset will be used are the most relevant
factors to consider when assessing which party direct party directs the use of the identified
asset.
How and for what purpose an asset is used is SINGLE CONCEPT (i.e., how an asset is used
is not assessed separately from for what purpose an asset is used).

When evaluating whether a customer has the right to change how and for what purpose
the asset is used throughout the period of use, the focus should be on whether the
customer has the decision making rights will that most affect the economic benefits
that will be derived from the use of the asset. The decision-making rights that are most
relevant are likely to depend on the nature of the asset and the terms and conditions of
the contract.

Ind As 116 provides the following examples of decision- making rights that grant the right
to change how and for what purpose an asset is used:

Particulars Examples
The right to change the type (i)  Deciding whether to use a shipping container to
of output that is produced transport goods or for storage
by the asset (ii) Deciding on the mix of products sold from a retail unit
The right to change when Deciding when an item of machinery or a power plant will
the output is produced be used
The right to change where (i) Deciding on the destination of a truck or a ship
the output is produced (ii) 
Deciding where a piece of equipment is used or
deployed
 INDIAN ACCOUNTING STANDARD 116: LEASES 215

The right to change whether Deciding whether to produce energy from a power plant
the output is produced and and how much energy to produce from that power plant
the quantity of that output

IMPORTANT POINTS TO BE CONSIDERED

1. The customer does not need the right to operate the underlying asset to have
the right to direct its use, i.e. the customer may direct the use of an asset that is
operated by supplier’ s personnel.
2. The relevant decisions about how and for what purpose an asset is used are predetermined
then Significant judgement may be required to assess whether a customer designed
the asset (or specific aspects of the asset) in a way that predetermines how and for
what purpose the asset will be used throughout the period of use.

  QUESTION 9

Right to direct the use of an asset

Customer X enters into a contract with Supplier Y to use a vehicle for a five- year period.
The vehicle is identified in the contract. Supplier Y cannot substitute another vehicle unless
the specified vehicle is not operations (for e.g. if it breaks down). Under the contract:
 Customer X operates the vehicle (i.e., drives the vehicle) or directs other to operate
the vehicle (for e.g. hires a driver).
 Customer X decided how to use the vehicle (within contracture limitations). For example,
throughout the period or use, Customer X decides where the vehicle goes, as well as
when or when or whether it is used and what it is used for Customer X can also change
these decisions throughout the period of use.
 Supplier Y prohibits certain used of the vehicle (for e.g., moving it overseas) and
modifications to the vehicle to protect its interest in the asset.
Whether Customer X has the right to direct the use of vehicle throughout the period
of lease?

SOLUTION:
Yes, Customer X has the right to direct the use of the identified vehicle throughout the
period of use because it has the right to change how the vehicle is used, when or whether
the vehicle is used, where the vehicle goes and what the vehicle is used for.
Supplier Y’s limits on certain uses for the vehicle and modifications to it are considered
protective right that define the scope of Customer X’s use of the asset, but do not affect
the assessment of whether Customer X directs the use of the asset.
216 INDIAN ACCOUNTING STANDARD 116: LEASES

  QUESTION 10

Right to direct the use of an asset

Entity A contracts with Supplier H to manufacture parts in a facility. Entity A designed
the facility and provided its specifications. Supplier H owns the facility and the land. Entity
A specifies how many parts it needs and when it needs the parts to be available. Supplier
H operates the machinery and makes all operation decisions including how and when the
parts are to be produced, as long as it meets the contractual requirements to deliver the
specified number on the specified date. Assuming supplier H cannot substitute the facility
and hence is an identified asset.
Which party has the right to control the use of the identified asset (i.e. equipment) during
the period of use?

SOLUTION
Entity A does not direct the use of the asset that most significantly drives the economic
benefits because Supplier H determines how and when the equipment is operated once the
contract is signed. Therefore, Supplier H has right to control the use of the identified
asset during the period of use. Although Entity A stipulates the product to be provided and
has input into the initial decisions regarding the use of the asset through its involvement
in the design of the asset, it does not have decision making rights over how and for what
purpose the asset will used over the asset during the period of use. This arrangement is a
supply agreement, not a lease.

  QUESTION 11

Right to direct the use of an asset

Entity L enters into a five – year contract with Company A ship over for the use of an
identified ship. Entity L decides whether and what cargo will be transported, and when
and to which ports the ship will sail throughout the period of use, subject to restrictions
specified in the contract. These restrictions prevent Entity sailing the ship into waters
at a high risk of piracy or carrying explosive materials as cargo. Company A operates and
maintains the ship, and is responsible for safe passage.
Who has right to direct the use of the ship during the period of use?

SOLUTION
Entity L has the right to direct the use of the ship. The contractual restrictions are
protective rights. In the scope of its right of use, Entity L determines how and for what
purpose the ship is used throughout the five year period because it decides where and when
the ship sails, as well as the cargo that it will transport. Entity L has the right to change
these decisions throughout the period of use. Therefore, the contract contains a lease.
 INDIAN ACCOUNTING STANDARD 116: LEASES 217

CONCEPT 7: SEPARATION OF LEASE

AND NON- LEASE COMPONENTS

A. IDENTIFYING AND SEPARATING LEASE COMPONENTS OF A CONTRACT

Sometimes, there are contracts that contain rights to use multiple assets (For e.g., a
building and an equipment, multiple pieces of equipment, etc.). The right to use each such
asset is considered as a separate’ lease component ONLY IF BOTH the following conditions
are satisfied:

♦ The lessee can benefit from the use of the asset either on its own OR together with
other resources that are readily available to the lessee (i.e., goods or services that
are sold or leased separately, by the lessor or other suppliers, or that the lessee has
already obtained from the leesor or in other transactions or events) AND
♦ The underlying asset is nether dependent on, not highly interrelated with, the other
underlying assets in the contract.

If one or both of these criteria are not met then, the right to use multiple assets is
considered a single lease component, i.e., not a separate lease component. Let us have a look
at the following illustration to have a better understanding:

  QUESTION 12

Identifying and separating lease components

Scenario A:
A lessee enters a lease of an excavator and the related accessories (for e.g., excavator
attachments) that are used for mining purposes. The lessee is a local mining company that
intends to use the excavator at a copper mine. How many lease and non-lease components
are there?

Scenario B:
Assume the same facts as in Scenario A, except that the contract also conveys the right to
use an additional loading truck. This loading truck could be deployed by the lessee for other
uses (for e.g. to transport iron ores at another mine).

SOLUTION:
Scenario A:
The lessee would be unable to benefit from use of the excavator without also using the
accessories. Therefore, the excavator is dependent upon accessories. Thus, from the
perspective of the lessee, the contract contains one lease component.
218 INDIAN ACCOUNTING STANDARD 116: LEASES

Scenario B:
The lessee can benefit from loading truck on its own together with other readily available
resources because the loading truck could be deployed for other uses independent of the
excavator the lessee can also benefit from the use of the excavator on its own or together
with other readily available resources.
Thus, from the perspective of the lessee, the contract contains tow lease components, viz.,
a lease of the excavator (together with the accessories) and a lease of the loading truck.

B. SEPARATING LEASE COMPONENTS FROM NON-LEASE COMPONENTS

There may be many contracts containing a lease coupled with an agreement to purchase
or sell other goods or services (i.e., the non-lease components under Ind AS 116). For
example, a supplier may lease a truck and also operate the leased asset on behalf of
a customer (i.e., provide a driver). This service is not related to securing the use of
the truck. Only items that contribute to securing the output of the asset are lease
components. In this example, only the use of the truck is considered a lease component.
Similarly, costs incurred by a supplier to provide maintenance on an underlying asset, as
well as the materials and supplies consumed as a result of the use of the asset, are not
lease components.

The non-lease components are identified and accounted for separately from the lease
component in accordance with other standards. For e.g., the non-lease components may
be accounted for as executory arrangements by lessees (customers) or as contracts
subject to Ind AS 115 by lessors (suppliers).

Costs related to property taxes and insurance do not involve the transfer of a good or
service. Consequently, if these costs are fixed in the contract, they should be included in
the overall contract consideration to be allocated to the lease and non-lease components.

  QUESTION 13

Identifying different components in the contract

Entity L rents an office building from landlord M for a term of 10 years. The rental contract
stipulates that the office is fully furnished and has a newly installed and tailored HVAC
system. It also requires Landlord M to perform all common area maintenance (CAM) during
the term of the arrangement. Entity L makes single monthly rental payment and does not
pay for the maintenance separately. The office building has a useful life of 40 years and the
HVAC system and office furniture each has a life of 15 years.
What are the units of account in the lease?
 INDIAN ACCOUNTING STANDARD 116: LEASES 219

SOLUTION
There are three components in the arrangement- the building assets (office building and
HVAC) the office furniture, and the maintenance agreement.
The office building and HVAC system are once lease component because they cannot function
independently of each other. The HVAC system was designed and tailored specifically to
integrated into the office building and cannot be removed and used in another building
without incurring substantial costs. These building assets are a lease component because
they are identified assets for which Entity L directs the use.
The office furniture functions independently and can be used on its own. It is also a lease
component because it is a group of distinct asset for which Entity L directs the use.
The office furniture functions independently and can be used on its own, It is also a lease
component because it is a group of distinct assets for which Entity L directs the use.
The maintenance agreement is a non-lease component because it is contract for service and
not for the use of a specified asset.

C.OPTIONAL EXEMPTION OF USING PRACTICAL

EXPEDIENT TO NOT TO SEPARATE NON-LEASE COMPONENT

Ind AS 116 provides a practical expedient that permits lessees to make an accounting
policy election, by CLASS OF UNDERLYING ASSET, to account for each separate
lease component of a contract and any associated non-lease components as a SINGLE
LEASE COMPONENT. It is important to note the such practical expedient is not
permissible for lessor.

Making this election relieves the lessee of the obligation to perform a pricing allocation,
although it will increase the total lease liability to be recorded on its balance sheet. This
expedient is not available for lessors. Lessees that make the policy election to account
for each separate lease component of a contract and any associated non-lease components
as a SINGLE LEASE COMPONENT, allocate ALL of the contract consideration to
the lease component.

D. Determining and allocating the consideration in the contract – Lessee

Lessees that do not make an accounting policy election (by class of underlying asset) to use
the practical expedient, as discussed above, to account for each separate lease component
of a contract and any associated non-lease components as a single lease component, are
required to allocate the consideration in the contract to the lease and non-lease components
on a RELATIVE STAND-ALONE PRICE BASIS.
220 INDIAN ACCOUNTING STANDARD 116: LEASES

Lessess are required to use observable stand-alone prices (i.e., prices at which a customer
would purchase a component of a contract separately) when available if observable stand-
alone prices are not readily available, lessees estimate stand-maximising the use of
observable information.

  QUESTION 14

Activities which are not components of a lease contract

A lessee enters into a five-year lease of equipment, with fixed annual Payment of `8,000
for rent, `1,500 for maintenance and ` 500 of administrative tasks, How the consideration
would be allocated?

SOLUTION
The contract contains two components, viz a lease component (lease of equipment) and
a non-lease component (maintenance) the amount paid for administrative task does not
transfer a good service to the lessee.
Assuming that the lessee does not elect to use the practical expedient as per para 15 of
Ind AS 116, both the lessee and the lessor account for lease of equipment and maintenance
components separately and the administration Charge is included in the total consideration
to be allocated between those components, Therefore, the total consideration in the
contract of ` 50,000 will be allocated to the lease component (equipment) and the non-lease
component (maintenance).

  QUESTION 15

Allocating contract consideration to lease and non-lease component- Lessees

A lessee enters into a lease of equipment. The contract stipulates the lessor will perform
maintenance of the leased equipment and receive consideration for the at maintenance
service. The contract includes the following fixed prices for the lease and-lease component:

Lease `80,000
Maintenance ` 10,000
Total ` 90,000
Assume the stand-alone prices cannot be readily observed, so the lessee
makes estimates, maximising the use of observable information, of the
lease and non-lease components, as follows:
Lease ` 85,000
 INDIAN ACCOUNTING STANDARD 116: LEASES 221

Maintenance ` 15,000
Total ` 1,00,000
In the given scenario, assuming lessee has not opted the practical
expedient, how will the lessee allocate the consideration to lease and no-
lease component?

SOLUTION
The stand-alone price for the lease component represents 85% (i.e., ` 85,000 / ` 1,00,000)
of total estimated stand-alone prices. The lessee allocated the consideration in contract
(i.e., ` 90,000), as follows:

Lease ` 76,500

Maintenance **` 13,500

Total ` 90,000

•  90,000x85%
•  ` 90,000x 15%

E. CONTRACT COMBINATIONS

Ind AS 116 requires that two or more contracts entered into at or near the same time with
the same counterparty (or related parties of the counterparty) be considered a single’
contract IF ANY ONE of the following criteria is met:

The contracts are The amount of The right to use the

negotiated as a consideration to be underlying assets
package with an paid in one contract conveyed in the
overall commercial OR depends on the price OR contracts (or some
objective that cannot or performance of the of the right to use
be understood without other contract underlying assets
considering the conveyed in each of the
contracts together contracts) are a single
lease component
 222 INDIAN ACCOUNTING STANDARD 116: LEASES

F. PORTFOLIO APPLICATION

Ind AS 116 applies to individual leases. However, entities that have a large number of leases
of similar assets (for e.g., leases of a fleet of similar rolling stock) may face practical
challenges in applying the leases model on a lease-by-lease basis.

Thus, Ind AS 116 includes a practical expedient that allows entities to use a portfolio
approach for lease with similar characteristics if the entity reasonably expects that the
effects of the financial statements would not differ materially from the application of the
standard to the individual leases in that portfolio.

CONCEPT 8: KEY CONCEPTS

A. INCEPTION AND COMMENCEMENT OF LEASE

Ind AS 116 requires customers and suppliers to determine whether a contract is or contains
a lease at the inception of the contract.
The inception date is defined as the earlier of the following dates:

♦ Date of a lease agreement

♦ Date of commitment by the parties to the principal terms and conditions of the lease
The commencement date is defined as the date on which a lessor makes an underlying asset
available for use by a lessee. Where the underlying asset’ is an asset that is the subject
of a lease, for which the right to use that asset has been provided by lessor to a lessee.
If a lessee takes possession of, or is given control over, the use of the underlying asset
before it begins operations or making lease payments under the terms of the lease, the lease
term has commenced even if lessee is not required to pay rent or the lease arrangement
states the lease commencement date is a later date.
The timing of when lease payments being under the contract does not affect the
commencement date of the lease.
As discussed earlier, inception date is the date when an entity shall assess if the contract
is or contains lease. While the commencement date is relevant because on that date:

(i) a lessee (except where the exemption of short-term lease or low- value asset is taken)
initially recognizes a lease liability and related Right of Use Asset (hereinafter
referred ROU Asset) on the commencement date
(ii) a lessor (for finance leases) initially recognises its net investment in the lease on the
commencement date.
Where, ROU Asset is defined as an asset that represents a lessee’s right to use an
underlying asset for the lease term.
 INDIAN ACCOUNTING STANDARD 116: LEASES 223

B. LEASE TERM

Determination of lease term is a very curcial step before the calculation of Lease Liability
and the corresponding ROU Asset. In simple terms, lease term is the usummation of the
following:

NON CANCELLABLE Periods covered by an Periods covered by an

PERIOD option to EXTEND the option to TRRMINATE
lease if the lessee is the lease if the lessee is
reasonably certain TO reasonably certain NOT
exercise that option TO exercise that option

  QUESTION 16 – DETERMINING THE LEASE TERM

Scenario A:
Entity ABC enters into a lease for equipment that includes a non-cancellable term of six
years and a two-year fixed prices renewal with future lease payment that are intended to
approximate market rates at lease inception. There are no termination penalties or other
factors indicating that Entity ABC is reasonably certain to exercise the renewal option.
What is the lease term?

Scenario B:
Entity XYZ enters into a lease for a building that includes a non-cancellable term of eight
years and a two-year market prices renewal option. Before it takes possession of the
building, Entity XYZ pays for leasehold improvements. The leasehold improvements
Are expected to have significant value at the end of eighty years, and that value can only be
realised through continued occupancy of the lease property What is the lease term?

Scenario C:
Entity PQR enters into a lease for an identified retail space in a shopping centre, The
retail space will be available to Entity PQR for only the months of October, November and
December during a non-cancellable term of seven years. The lessor agrees to provide the
same retail space for each of the seven years. What is the lease term?

SOLUTION:
Scenario A:
At the lease commencement date, the lease term is six years (being the non-cancellable
period) the renewal period of two years is not taken into consideration since it is mentioned
that Entity ABC is not reasonably certain to exercise the option.
 224 INDIAN ACCOUNTING STANDARD 116: LEASES

Scenario B:
At the lease commencement, Entity XYZ determines that is reasonably certain to exercise
the renewal option because it would suffer a significant economic penalty if it abandoned
the leasehold improvements at the end of the initial non-cancellable period of eight years.
Thus, at the lease commencement, Entity XYZ concludes that the lease term is ten years
(being eight years of no-cancellable period plus the renewal period of two years where the
lessee is reasonable certain to exercise the option

Scenario C:
At the lease commencement date, the lease term is 21 months (three months per year over
the seven annual periods as specified in the contract), i.e., the period over which Entity PQR
controls the right to use underlying asset.

C. CANCELLABLE LEASES
In determining the lease term and assessing the length of the non-cancellable period of
a lease, an entity shall apply the definition of a contract and determine the period for
which the contract is enforceable. A ‘contract’ is defined as an agreement between two
or more parties that creates enforceable rights and obligations.
An arrangement is not enforceable if:

(i) both the lessor and lessee each have the right to terminate the lease without
permission from the other party; AND
(ii) with no more than an insignificant penalty

Any non-cancellable periods (by the lessee and the lessor) in contracts that meet the
definition of a lease are considered part of the lease term. If only the lessor has the
right to terminate a lease, the period covered by the option to terminate the lease is
included in the non-cancellable period of the lease. If only the lessee has the right to
terminate a lease, that right is a termination option that is considered when determining
the lease term.
If both the lessee and the lessor can terminate the contract without more than an
insignificant penalty at any time at or after the end of the non-cancellable term, then
there are no enforceable rights and obligations beyond the non-cancellable term (i.e.,
the lease term is limited to the non- cancellable term). However, if only the lessee
holds a renewal option, there may be other factors to consider determining whether the
lessee is reasonably certain to extend the lease, including economic disincentives (as
discussed above).
This can be understood better with the help of the following illustrative situation:
 INDIAN ACCOUNTING STANDARD 116: LEASES 225

Suppose the term of a contract is 10 years and the non-cancellable / lock-in period is 6
years. The lease term shall be as follows:

If the termination option If the termination option is If the termination option

is with ‘Lessor’ with ‘Lessee’ is with ‘Both (i.e., any
party can terminate)
The lease term shall be The lease term shall be 10 years The lease term shall be 6
10 years. reasonable certainty. years.
Because even after 6th Because after the expiry of 6th Because after 6th
year, the lessee would year, though the lessee is not year, either party can
be contractually bound contractually bound till 10th year, terminate the contract
refuse to make the i.e., the lessee can refuse to make without the consent
payment till the expiry payment anytime without lessor’s of the other party and
of the contract sand permission but, it is assumed hence, the contract is
also, has the right unless that the lessee is reasonably not enforceable after 6th
lessor terminates the certain that is will not exercise year ONLY in case there
contract. this option to terminate. Hence, is insignificant penalty
though there is no enforceable for termination.
obligation from lessee’s point of
view beyond 6th year but, basis
the said assumption, the lease
term shall be 10) years.

D. REASSESSMENT OF LEASE TERM AND PURCHASE OPTIONS (FOR LESSEES)

After the lease commencement, Ind AS 116 requires lessees to monitor leases for significant
changes that could trigger a change in the lease term. Lessees are required to reassess
the lease term upon the occurrence of either a significant event OR A significant change
in the circumstances that:

Affects whether the lessee is reasonably

IS WITHIN THE certain to exercise / not to exercise
CONTROL OF THE renewal, termination and/or purchase
LESSEE option, not previously included in its
determination of the lease term

Following are some of the examples of significant events or significant changes in

circumstances within the lessee’s control:
226 INDIAN ACCOUNTING STANDARD 116: LEASES

1) Constructing significant leasehold improvements that are expected to have significant

economic value for the lessee when the option becomes exercisable
2) Making significant modifications or customisations to the underlying asset
3) Making a business decision that is directly relevant to the lessee s ability to exercise,
or not to exercise, an option (e.g., extending the lease of a complementary asset or
disposing of an alternative asset)
4) Subleasing the underlying asset for a period beyond the exercise date of the option

  QUESTION 17

Re-assessment of exercise of lease extension option

Retailer M enters into a five- year lease for a building floor, followed by two successive
five-year renewal options. On the commencement date, Retailer M is not reasonably certain
to exercise the extension option. At the end of third year, Retailer M extended to include
another floor from year 4 due to a business acquisition. For this purpose, the lessee concludes
a separate seven-year lease for an additional floor in the building already leased. Is Retailer
M required to reassess the lease term in the case?

SOLUTION:
Ind AS 116 requires a lease to reassess the lease term if there is charge in business
decision of the company which is directly relevant to exercising or not exercising an option
to renew/extent the lease. In the given case, the retailer M at the end of third year has
extended to include another floor in the same building on account of acquiring another
company. As Retailer M has entered into fresh lease of another floor for a seven-year
term, it is reasonably certain to exercise the renewal option of original lease for a further
five-year term. Hence Retailer M will have to reassess the lease term at end of third year.

  QUESTION 18

Re-assessment of non-cancellable period of lease

Company N has taken 10 vehicles on lease for an initial period of 5 years with an extension
option at the option of the lessee for a further period of 5 years at the same rental amount,
the remaining useful life of the vehicles as on the commencement date of the lease is 15
years,. Company N has determined at the commencement date that it is reasonably certain
to exercise the extension option and hence it has taken a period of 10 years for the lease.
At the end of 4th year, there is an announcement by the government that all the cars of this
particular model have to be discontinued from the road within 1 year due to the change in
the pollution norms in the country. Will the lease term be reassessed in the case?
 INDIAN ACCOUNTING STANDARD 116: LEASES 227

SOLUTION:
In the given case, as per Ind AS 116, the announcement by the government to discontinue
the use of the underlying asset will prohibit the lessee form exercising the extension option
that was already included in the non- cancellable period by Company N and hence, Company
N will reassess the non-cancellable period to exclude the extension option of 5 years.

Reassessment of lease term and purchase options (for lessors):

Ind AS 116 requires the lessor to revise the lease term to account for the lessee’s exercise
of an option to extend or terminate the lease or purchase the underlying asset, when
exercise of such options was not already included in the lease term.

D. LEASE PAYMENTS

Lease payments are defined as payments made by a lessee to a lessor relating to the right
to use an underlying asset during the lease term, comprising the following:

(a) Fixed payments(includingin-substance fixed payments),less any lease incentives

(b) Variable lease payments that depend on an index or a rate
(c) the exercise price of a purchase option if the lessee is reasonably certain to exercise
that option
(d) payments of penalties for terminating the lease, if the lease term reflects the
lessee exercising an option to terminate the lease
For the lessee, lease payments also include amounts expected to be payable by the lessee
under residual value guarantees.
For the lessors, lease payment instead includes residual value guarantees provided by
the lessee, a party related to the lessee or a third party unrelated to the lessor that is
financially capable of discharging the obligations under the guarantee.

Fixed payments
less incentives
Expected
residual
Variable
value
LEASE payments
guarantee
(e.g. CPI/
PAYMENTS
index / rate)
Penalty for
terminating (if Exercise price of
reasonably certain purchase option
(reasonably certain)
 228 INDIAN ACCOUNTING STANDARD 116: LEASES

Exclusion of payments for calculating lease liability:

a. Lease payments do not include payments allocated to non-lease components of

a contract, unless the lessee elects to combine non-lease components with a lease
component and to account for team a single lease component.
b. Variable lease payments that do not depend on index or rate.

FIXED LEASE PAYMENTS

Fixed payments’ are defined as payments made by a lessee to a lessor for the right to use
an underlying asset during the lease term, excluding variable lease payments.
Fixed payments can be a fixed amount paid at various intervals in a lease.

  QUESTION 19

Determining the fixed payments

Entity M and Lessor A enter into a 10-year lease of an office building for fixed annual lease
payments of ` 200,000. Per the terms of the lease agreement, annual fixed lease payments
comprise `170,000 for rent and ` 30,000 for real estate taxes.
What are the fixed lease payments for purposes of classifying the lease?

SOLUTION
The fixed lease payments are ` 2,00,000. Although real estate taxes are explicitly stated
in the lease contract, they do not represent a separate non-lease component as they do
not provide a separate good or service,. The right to use the office building is the only
component. The annual lease payment of ` 2,00,000 represent payments related to that
single lease component.

IN-SUBSTANCE FIXED LEASE PAYMENTS

As mentioned above, lease payments also include any in substance fixed lease payments
which are the payments that may, in form, contain variability but that, in substance, are
unavoidable. Examples may include:

(a) If there is more than one set of payments that a lessee could make, but only of those
sets of payments is realistic. In such a case, an entity shall consider the realistic set
of payments to be lease payments.
(b) If there is more one realistic set of payments that a lessee could make, but it must
make at least one of those sets of payments. In such a case, an entity shall consider
the set of payments that aggregates to the lowest amount (on a discounted basis) to
be lease payments.
 INDIAN ACCOUNTING STANDARD 116: LEASES 229

  QUESTION 20

In substance fixed lease payments

Entity Q enters into a seven-year lease for a piece of machinery. The contract sets out the
lease payments as follows.

- If Q uses the machinery within a given month, then an amount of 2,000 accrues for that
month.
- If Q does use the machinery within a given month, then an amount of 1,000 accrues for
that month
What is considered as lease payment in this case?

SOLUTION:
Q considers the contract and notes that although the lease payments contain variability
based on usage, and there is a realistic possibility that Q may not use the machinery in some
months, a monthly payment of 1,000 unavoidable. Accordingly, this is in –substance fixed
payment, and is included in the measurement of the lease liability.

  QUESTION 21

In substance fixed lease payment

Entity P enters into five-year lease for office space with Entity Q. The initial base rent is `
1Lakh per month, Rents increase by the greater of 1 % of Entity P’s generated sales or 2%
of the previous rental rate on each anniversary of the lease commencement date. What are
the lease payments for purposes of measuring lease liability?

SOLUTION:
In the given case, the lease payments for purposes of classifying the lease are the fixed
monthly payments of ` 1 lakh plus minimum annual increases of 2% of the previous rental
rate. Entity P is require to pay no less than a 2% increase regardless of the level of sales
activity; therefore, this minimum level of increase is in substance fixed lease payment.

  QUESTION 22

In substance fixed lease payments

Company N leases a production line. The lease payments depends on the number of operating
hours of the production line i.e., N has to pay ` 1,000 per hour of use. The annual minimum
payment is ` 10,00,000. The expected usage per year 1,500 hours
230 INDIAN ACCOUNTING STANDARD 116: LEASES

SOLUTION:
The lease contains in substance fixed payments of ` 10,00,000 per year, which are included
in the initial measurement of lease liability, the additional ` 5,00,000 that Company N
expects to pay per year variable payments that do not depend on index or rate but usage.

LEASE INCENTIVES
‘Lease incentives’ is defined as payments made by a lessor to a lessee associated with a
lease, or the reimbursement or assumption by a lessor of costs of a lessee.
A lease agreement with a lessor might include incentives for the lessee to sign the lease,
such as an upfront cash payment to the lessee, payment of costs for the lessee (such as
moving / transportation expenses) or the assumption by the lessor of the lessee’s pre-
existing lease with a third party.

VARIABLE LEASE PAYMENTS THAT DEPEND ON AN INDEX OR A RATE:

‘Variable lease payments’ are defined as the portion of payments made by a lessor for
the right to use an underlying asset during the lease that varies because of changes in
facts or circumstance occurring after the Commencement date, other than the passage
of time.
These may include, for e.g., payments linked to a consumer price index, payments linked
to a benchmark interest rate or payments that vary to reflect changes in market rental
rates. Such payments are included in the lease payments and are measured using the
prevailing index or rate at the measurement date (e.g., lease commencement date for initial
measurement).
Lessees subsequently remeasure the lease liability if there is a change in the cash flows
(i.e., when the adjustment to the lease payments takes effect) for future payments
resulting from a change in index or rate used to determine lease payments.

  QUESTION 23

Variable lease payments that depend on an index or rate

An entity enters into a 10-year lease of property, the lease payment for the first year is
` 1,000 The lease payment are linked to the consumer price index (CPI), i.e., not a floating
interest rate. The CPI at the beginning of the first year is 100. Lease payments are updated
at the end or every second year. At the end of year one, CPI is 105. At the end of year two,
the CPI is 108. What should be included in lease payments?
 INDIAN ACCOUNTING STANDARD 116: LEASES 231

SOLUTION:
At the lease commencement date, the lease payments are ` 1,000 per year for 10 years.
The entity does not take into consideration the potential future changes in the index. At
the end of year one, the payments have not changed and hence, the liability is not updated.
At the end of year two, when the lease payments change, the entity updated the remaining
eight lease payments to ` 1,080 per year (i.e., 1,000/100 x 108).

VARIABLE LEASE PAYMENTS THAT DO NOT DEPEND ON AN INDEX OR A RATE

Variable lease payments that do not depend on an index or rate and are not, in substance,
fixed as discussed above –In-substance fixed lease payments). Examples may include
payments such as those based on performance (for e.g., a percentage of sales) or
usage of the underlying asset (for e.g., the number of hours flown, the number of units
produced), are not included as lease payments. Instead, they are recognized in profit
or loss in the period in which the event that triggers the payment occurs (unless they
are included in the carrying amount of another asset in accordance with other IndAS).

 QUESTION 24

Variable lease payments that do not depend on an index or rate

Entity XYZ is a medical equipment manufacturer and a supplier of the related consumables.
Customer ABC operates a medical centre. Under the agreement entered into by both
parties, Entity XYZ grants Customer ABC the right to use a medical laboratory machine at
no cost and customer ABC purchase consumables for use in the equipment from Entity XYZ
at ` 100 each.
The consumables can only be used for that equipment and Customer ABC cannot use other
consumables as substitutes. There is no minimum purchase amount required in the contract.
Based on its historical experience, Customer ABC estimates that it is highly likely to
purchase at least 8,000 units of consumables annually. Customer ABC has appropriately
assessed that the arrangement contains a lease of medical equipment. There are no residual
value guarantees or other forms of consideration included in the contract. Whether these
payments affect the calculation of lease liability and ROU Asset? How does Entity XYZ and
Customer ABC would allocate these lease payments?

SOLUTION:
There are two components in the arrangement, viz., a lease of equipment and the purchase
of consumables.
232 INDIAN ACCOUNTING STANDARD 116: LEASES

Even though Customer ABC may believe that it is highly unlikely to purchase lesser than
8,000 units of consumables every year, in this example, there are no lease payment for
purposes of initial measurement (for Entity XYZ and Customer ABC) and lease classification
(for Entity XYZ).
Entity XYZ and Customer ABC would allocate the payments associate with the future
payments to the lese and consumables component of the contract.

  QUESTION 25

Variable lease payments

Entity A enters into a five- year lease of an office building. The lease payments are `
5,00,000 per year and the contract includes an additional water charge calculated as `
0.50 per litre consumed. Payments are due at the end of year. Entity A elects to apply the
practical expedient to combine lease and non-lease components

SOLUTION:
As stated above, payments are due at the end of the year. Entity A elects to apply the
practical expedient not to separate lease and non-lease components.
At the commencement date, Entity A measures the lease liability as the present value of the
fixed lease payments (i.e. five annual payments of 5,00,000) Although Entity A has elected
to apply the practical expedient to combine non-lease components (i.e. water charges) with
the lease component, Entity A excludes the non-lease component form its liability because
they are variable payments that depend on usage. That is, the nature of the costs does no
become fixed just because Entity A has elected not to separate them from the fixed lease
payments. Entity A recognises the payments for water- as a variable lease payment- in
profit or loss when they are incurred.
In contrast, if B does not elect to apply the practical expedient to combine lease and non-
lease components, then it recognises the payments for water as n operating expense in
profit or loss when they are incurred.

EXERCISE PRICE OF A PURCHASE OPTION

In the lessee is reasonably certain to exercise a purchase option, the exercise price is
included as a lease payment, i.e. entities consider the exercise price of asset purchase
option included in lease contracts consistently with the evaluation of lease renewal and
termination options (as discussed earlier).
 INDIAN ACCOUNTING STANDARD 116: LEASES 233

PENALTIES FOR TERMINATING A LEASE

If it is reasonably certain that the lessee will not terminate as lease , the lease term is
determined assuming that the termination option would not be exercised, and any termination
penalty is excluded from the lease payments. Otherwise, the lease termination penalty is
included as lease payment. The determination of whether to include lease termination
penalties as lease payments is similar to the evaluation of lease renewal options (as discussed
earlier).

RESIDUAL VALUE GUARANTEES (LESSEES)

‘Residual value guarantee’ is defined as a guarantee made to a lessor by a party unrelated

to the lessor that the value (or part of the value) of an underlying asset at the end of a
lease will be at least a specified amount.

For a lessee, lease payments include amounts expected to be payable by the lessee under
residual value grantees. A lessee may provide a guarantee to the lessor that the value of
the underlying asset it returns to the lessor at the end of the lease will be at least of a
specified amount. Such guarantees are enforceable obligation that the lessee has assumed
by entering into the lease. A lessee is required to remeasure the lease liability if there is a
change in the amounts expected to be payable under a residual value guarantee.

  QUESTION 26

Residual value guarantee included in lease payments

An entity (a lessee) enters into a lease and guarantees that the lessor will realise `20,000
form selling the asset to another party at the end of the lease. At lease commencement
based on the lessee’ estimate of the residual value of the underlying asset, the lessee
determines that it expects that it will owe ` 8,000 at the end of the lease. Whether the
lessee should include the said payment of ` 8,000 as a lease payment?

SOLUTION
The lessee should include the amount of `8,000 as a lease payment because it is expected
that it will one the same to the lessor under the residual value guarantee

Residual value guarantees (lessors):

Ind AS 116 requires lessors to include in the lease payments, any residual value guarantees
provided to the lessor by the lessee, a party related to the lessee,, or a third party unrelated
to the lessor that is financially capable of financially the obligations under the guarantee.
This amount included in the lease payments is different from that fort a lessee which only
includes the amount expected to be payable by lessee only (as discussed above).
234 INDIAN ACCOUNTING STANDARD 116: LEASES

INITIAL DIRECT COSTS

‘Initial direct costs’ are defined as the incremental costs of obtaining a lease that would
not have been incurred if the lease had not been obtained, except for such costs incurred
by a manufacture or lessor in connection with a finance lease.
Examples of costs included and excluded from initial direct costs is provided below.

Included Excluded
Commission (including payments to Employee salaries
employees acting as selling agents)
Legal fees resulting from execution of the Legal fees for services rendered before
lease the execution of the lease
Lease document preparation costs Negotiating lease term and conditions
incurred after the execution of the lease
Certain payments to existing tenants to Advertising
move out
Consideration paid for a guarantee of a Depreciation and amortization
residual asset by an unrelated third party

Lessees and lessors apply the same definition of initial direct costs. The requirements
under Ind AS 116 for initial direct costs are consistent with the concept of incremental
costs in Ind AS 115, Revenue from Contracts with Customers.

DISCOUNT RATES

Discount rates are used to determine the present value of the lease payments, which are
used to determine Right of use asset and Lease liability in case of a lessee and to measure
a lessor net investment in the lease.

For a Lessee

As per Ind AS 116, the Discount Rate to be used should be:

THE INTEREST RATE If not, then the lease

IMPCLICIT IN THE OR
shall use THE LESEE’S
LEASE, if that rate can INCREMENTAL
be readily determined. BORROWINGS RATE.

Where,
Interest rate implicit in the lease’ is defined as the rate of interest that causes following:
 INDIAN ACCOUNTING STANDARD 116: LEASES 235

The present The The fair The fair

value of lease unguaranteed value of the value of the
payments residual value underlying underlying
made by the asset asset
lessee for the
right to use
the underlying
asset

Lease payments are discounted using the interest rate implicit in the lease (as above to be
calculated from the perspective of lessor)if the rate can be readily determined. But if that
rate cannot be readily determined then the lessee used the incremental borrowing rate.
As discussed above, the lessee’s incremental borrowing rate is the rate of interest that
- The lessee would, have to pay to borrow over a similar term,
- and with a similar security,
- the funds necessary to obtain an asset of a similar value to the Right of use Asset
- in a similar economic environment.

CONCEPT 9: ACCOUNTING IN THE BOOKS OF LESSEE

STEP 1: INITIAL RECOGNITION AND MEASUREMENT

A lessee’ is defined as an entity that obtains the right to use an underlying asset for a
period of time in exchange for consideration.
At the commencement date, a lessee shall recognise a ROU Asset and a Lease Liability.
Ind AS 116 requires lessees to recognise a liability to make lease payments and an asset
representing the right to use the underlying asset (i.e., the ROU Asset) during the lease
for ALL leases (except for short-term leases and leases of low-value assets, if they choose
to apply such exemptions).

A. MEASURING THE LEASE LIABILITY

At the commencement date, a lessee initially measures the Lease liability at the present
value of the remaining lease payments to be made over the lease term, discounted
using the rate implicit in the lease (or if that rate cannot be readily determined, the
lessee’s incremental borrowing rate).
236 INDIAN ACCOUNTING STANDARD 116: LEASES

  QUESTION 27

Initial measurement of lease liability

Entity L enters into a lease for 10 years, with a single lese payment payable at the beginning
of each year. The initial lease payments ` 100,000 Lease payments will increase by the rate
or LIBOR each year. At the date of commencement of the lease, LIBOR is 2 per cent.
Assume that the interest rate implicit in the lease is 5 per cent. How lese liability is initially
measure?

B.MEASURING THE RIGHT-OF USE ASSET

A lessee initially measures the ROU Asset at COST, which consists of ALL of the following:

Payments make to lessor

Initial Measurement of before commencement
Lease liability date less lease incentives
received from lessor

Estimate of costs for

Initial direct costs
restoration/ dismantling
incurred by lessee
of underlying asset

On initial measurement, a lessee is required to recognise dismantling, removal and restoration

costs as part of the ROU Asset. Costs may be incurred at lease commencement or during
a particular period as a consequence of having used an underlying asset. Costs that are
incurred during a particular period as a consequence of having used the ROU Asset to
produce inventories are accounted for under Ind AS 2 inventories. The liability associated
with dismantling, removal and restoration costs is recognizes and measured n accordance
with Ind AS 37 Provisions, contingent Liabilities and Contingent Assets.

  QUESTION 28

Measuring right-of use asset

Entity Y and Entity Z execute a 12- year lease of a railcar with the following terms on
January 1 2016:
 The lease commencement date is February 1,2016.
 Entity Y must Entity Z the first monthly rental payment of ` 10,000 upon execution of
the lease.
 INDIAN ACCOUNTING STANDARD 116: LEASES 237

 Entity Z will pay entity Y ` 50,000 cash incentive to enter into the lease payable upon
lease execution.
Entity Y incurred ` 1,000 of initial direct cots, which are payable on February 1, 2016 Entity
Y calculated the initial lease liability as the present value of the lease payments discounted
using its incremental borrowing rate because the rate implicit in the lease could not be
readily determined; the initial lease liability is `850,000
How would Lessee Company measure and record this lease?

  QUESTION 29

Dismantling costs to be included in initial measurement of ROU Asset

Company H leases an aircraft for a period of 5 years. The aircraft must undergo a planned
check after every 1,00,000 flight hours. At the end of the lease, company H must have a
check performed (or refund the cost to the lessor), irrespective of the actual of fight
hours. What are the lease payments for purposes of calculating ROU asset?

SOLUTION:
In the given case, the legal requirement to perform a check after every 1,00,000 flight hours
does not directly lead to an obligation as it depends on future circumstances. However, as
the check must be carried out at the end of the lease irrespective of the actual number of
flight hours gives rise to an obligation.
As a result, company H has to recognize a provision for the costs of the final check (Present
value of the expected cost”) at the beginning of the lease term. At the same time, these
costs must be included in the cost of the right-of use (ROU) asset pursuant to para 24 (d)
of Ind AS 116.

STEP 2: SUBSEQUENT MEASUREMENT

A. RIGHT – OF USE ASSETS (ROU ASSET)

After the commencement date, the right- of use asset should be measured using a cost
model, unless it applies the revaluation model as specified under Ind AS 16.
Cost model for right – of – use assets:
To follow the cost model, an entity measures a right – of use asset at cost:

(a) Less accumulated depreciation and accumulated impairment losses (recognized in

accordance with Ind As 36, Impairment of Assets); and
(b) Adjusted for re-measurements of the lease liability specified in section 3.4.3
238 INDIAN ACCOUNTING STANDARD 116: LEASES

Depreciation for right – of use assets

ROU Assets measured under the cost model should be depreciated in accordance with the
depreciation requirements given in Ind AS 16, subject to the following:
- If the lease transfers ownership of the underlying asset to the lessee by the end of
the lease term, or if the cost of the ROU Asset reflects that the lessee will exercise a
purchase option, the ROU Asset should be depreciated from the commencement date to
the end of the useful life of the underlying asset;
- Otherwise the right of use asset should be depreciated from the commencement date to
the earlier of the end of the useful life of the ROU Asset and the end of the lease term.

B. LEASE LIABILITY
A lease Liability should be accounted for in a manner similar to other financial liabilities (i.e.,
on an amortised cost basis). Consequently, the lease liability is accreted using an amount
that produces a constant periodic discount rate on the remaining balance of the liability
(i.e., the discount rate determined at commencement, as long as a reassessment requiring
a change in the discount rate has not been triggered). Lease payments reduce the lease
liability when paid
Thus, after the commencement date, a lessee shall measure the lease liability by:
a. increasing the carrying amount to reflect interest on the lease liability;
b. reducing the carrying amount to reflect the lease payments made; and
c. remeasuring the carrying amount to reflect any reassessment or lease modification or to
reflect revised inn-substance fixed lease payments.

C. EXPENSE RECOGNITION
Lessees recognize the following items in expense for lease:
♦ Depreciation of the ROU Asset
♦ Interest expense on the Lease Liability
♦ Variable lese payment that are not included in the lease liability (for e.g., variable lease
payments that do not depend on an index or rate)
♦ Impairment of the ROU Asset

  QUESTION 30

Lessee Accounting
Entity ABC (lessee) inters into a three- year lease of equipment, Entity ABC agrees to make
the following annual payments at the end of each year:
 INDIAN ACCOUNTING STANDARD 116: LEASES 239

` 20,000 in year one

` 30,000 in year two
` 50, 000 in year three
For simplicity purposes, there are no other elements to the lease payments (like purchase
options, lease incentives from the lessor or initial direct costs), Assumed a discount rate
or 12% (which is Entity ABC’s incremental borrowing rate because the interest rate implicit
in the lease cannot be readily determined). Entity ABC depreciated the ROU Asset on a
straight-line basis over the lease term.
How would Entity ABC would account for the said lease under Ind AS 116?

  QUESTION 31

Subsequent Measurement using cost model

Company EFG enter into a property lease with Entity H. The initial term of the lease is 10
years with a 5 – year renewal option. The economic life of the property is 40 years and the
fair value of the leased property is ` 50 Lacs. Company EFG has an option to purchase the
property at the end of the lease term for `30 lacs. The first annual payment is ` 5 lacs
in the beginning of year with an increase of 3% every year in the beginning thereafter.
The implicit rate of interest is 9.04% Entity H gives Company EFG an incentive of ` 2 lacs
(payable at the beginning of year 2) which is to be used for normal tenant improvement.
Company EFG is reasonably certain to exercise that purchase option. How would EFG measure
the right-of use asset and lease liability over the lease term.

LEASES DENOMINATED IN A FOREIGN CURRENCY

Lessees apply Ind AS 21 the Effects of Changes in Foreign Exchange Rates, to leases
denominated in a foreign currency. Lessees remeasure the foreign currency- denominated
lease liability using the exchange rate at each reporting date, like they do for other
monetary liabilities. Any changes to the lease liability due to exchange rate changes are
recognised in profit or loss. Because the ROU Asset is a non-monetary asset measured at
historical cost, it is not affected by changes in the exchange rate.
This approach could result in volatility in profit or loss from the recognition of foreign
currency exchange gains or losses, but it will be clear to the users of financial statement
that the gains or losses result solely from changes in exchange rates.

STEP III: REMEASUREMENT

Ind AS 116 requires lessees to REMEAURE LEASE LIABILITIETS upon a change in lease
payments on account of ANY of the following:
240 INDIAN ACCOUNTING STANDARD 116: LEASES

The reassessment of The reassessment of

lease term on account of whether the lessee is In – substance fixed
reasonable certainty to reasonably certain to lease payments
exercise/not exercise exercise an option to
of extension and/or purchase the underlying
termination option asset

The amounts expected to Future lease payments

be payable under residual resulting from a change
value guarantees in an index or rate

When to use the ‘original and a revised’ discount rate?

Revised Discount Rate Original Discount Rate

Lessees use a revised discount rate when Lessees use the original discount rate when
lease payments are updated for lease payments are updated for
-reassessment of the lease term OR -a change in expected amount for residual
-a reassessment of a purchase option. value guarantees AND

The revised discount rate is based on - Payment dependent on an index or rate,

the interest rate implicit in the lese for unless the rate is a floating interest
the lease for the REMAINDER of the rate.
lease term. If that rate cannot be readily - The variability of payments is resolved
determined, the lessee uses its incremental so that they become in –substance
borrowing rate. fixed payments.

  QUESTION 32

Remeasurement of a lease with variable lease payments

Entity W entered into a contract for lease of retail store with Entity J on January
01/01/2017. The initial term of the lease is 5 years with a renewal option of further
3years. The annual payments for initial terms and renewal term is `100,000 and `110,000
respectively. The annual lease payment will increase based on the annual increase in the
CPI at the end of the preceding year. For example, the payment due on 01/01/18 will be
based on the CPI available at 31/12/17
Entity W’s incremental borrowing rate at the lease inception date and as at 01/01/2020 is
 INDIAN ACCOUNTING STANDARD 116: LEASES 241

5% and 6% respectively and the CPI at lease commencement date and as at 01/01/2020 is
120 and 125 respectively.
At the lease commencement date, Entity W did not have a significant economic incentive
to exercise the renewal option. In the first quarter of 2020, Entity W installed unique
lease improvements into the retail store with an estimated five-year economic life. Entity
W determined that it would only recover the cost of the improvements if it exercises
the renewal option, creating a significant economic incentive toext end.
Is Entity W required to remeasure the lease in the first quarter of 2020?

STEP IV: LEASE MODIFICATINS

A lease modification is a change in the scope of a lease, or the consideration for a lease, that
was not part of the original terms and conditions of the lese Fore.g, adding or terminating
the right to use one or more underlying assets, or extending or shortening the contractual
lease term).
The following are examples of lease modifications that may be negotiated after the lease
commencement date:
♦ A lease extension
♦ Early termination of the lease
♦ A change in the timing of lease payments
♦ Leasing additional space in the same building
♦ Surrendering a part of the underlying asset.
If a lease is modified (as stated above), the modified contract is evaluated to determine
whether it is or contains a lease. If a lease continues to exist, lease modification can result  in:
♦ A separate lease OR
♦ A change in the accounting for the existing lease (i.e., not a separate lease).
The exercise of an existing purchase or renewal option or a change in the assessment of
whether such options are reasonably certain to be exercised are not lease modifications
but can result in the remeasuremnt of Lease Liabilities and ROU Assets (Remeasurement
– as discussed above).

MODIFICATION – SEPARATE LEASE

A lease modification is accounted for as a separate lease if both:
a. The modification increases the scope of the lease by adding the right to use one or more
underlying assets; and
b. The consideration for the lease increases by an amount commensurate with the standalone
price for the increase in scope.
242 INDIAN ACCOUNTING STANDARD 116: LEASES

  QUESTION 33

Modification that is a separate lease

Lessee enters into a 10-year lease for 2,000 square metresof office space. At the beginning
of Year 6, Lessee and Lessor agree to amend the original lease for the remaining five
years to include an additional 3,000 square metresof office space in the same building.
The additional space is made available for use by Lessee at the end of the second quarter
of Year 6. The increase in total consideration for the lease is commensurate with the
current market rate for the new 3,000 square metresof office space, adjusted for
the discount that Lessee receives reflecting that Lessor does not incur costs that it
would otherwise have incurred if leasing the same space to a new tenant (for example,
marketingcosts).
How should the said modification be accounted for?

SOLUTION:
Lessee accounts for the modification as a separate lease, separate from the original 10-
year lease because the modification grants Lessee an additional right to use an underlying
asset, and the increase in consideration for the lease is commensurate with the stand-
alone price of the additional right-of-use adjusted to reflect the circumstances of
the contract. In this example, the additional underlying asset is the new 3,000 square
metres of office space. Accordingly, at the commencement date of the new lease (at the
end of the second quarter of Year 6), Lessee recognises a ROU Asset and a lease liability
relating to the lease of the additional 3,000 square metres of office space. Lessee does
not make any adjustments to the accounting for the original leaseof2,000 square meters
of office space as a result of this modification.

Modification – Not Separate Lease:

If a lease modification fails the test above (e.g. additional right of use granted, but not at
a standalone price). Or the modification is of any other type (e.g. a decrease in scope from
the original contract), the lessee must modify the initially recognised components of the
lease contract.
The accounting treatment required for lease modifications that are not accounted for
as separate leases is summarised below:

• Remeaserue lease liability using revised discount rate (i)

Decrease in • Decrease right –of- use asset by its relative scope compared to
scope the original lease (2)
• Difference between (1) and (2) recognised in P&L
 INDIAN ACCOUNTING STANDARD 116: LEASES 243

All other lease • Remeasure lease liability using revised discount rate
modification • Remeasure right of -use asset by same amount

The implicit rate in the lease is to be used. If it cannot be readily determined, the incremental
rate of borrowing is to be used.
The re-measurement above occur as of the effective date of the lease modification on
prospective basis.
In some cases, the lessee and lessor may agree to a modification to the lease contract that
starts at a later date (i.e., the terms of the modification take effect at a date than the
date when both parties agreed to the modification). This can be understood with help of a
following example:

Lease Modification

Change in Consideration Change in lease term Change in scope

Increase Decrease Decrease Increase

- Remeaure the - Derecognise the Consideration not Consideration

lease liability at lease liability and commensurate commensurate
modification date ROU Asset to to stand –alone to stand –
- Make corresponding reflect the partial selling price alone selling
adjustment to ROU or full termination price
Asset of the lease
- Recognise in P&L
the gain or loss on
termination of the
lease

- Remeasure the lease liability - Increase in scope

at modification date of the lease of
- Make corers ponding Underlying asset to
adjustment to ROU Asset be accounted as a new
244 INDIAN ACCOUNTING STANDARD 116: LEASES

  QUESTION 34

Modification that increases the scope of the lease by extending the contractual lease
term
Lessee enters into a 10-year lease for 5,000 square metres of office space. The annual
lease payments are `1,00,000 payable at the end of each year. The interest rate implicit
in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the
commencement date is 6% p.a. At the beginning of year 7 , lessee and lessor agree to
amend the original lease by extending the contractual lease term by four years. The
annual lease payments are unchanged (i.e., `1,00,000 payable at the end of each year
from Year 7 to Year 14). Lessee’s incremental borrowing rate at the beginning of Year 7
is 7%p.a.
How should the said modification be accounted for?

  QUESTION 35

Modification that decreases the scope of the lease

Lessee enters into a 10-year lease for 5,000 square metres of office space. The annual
lease payments are `50,000 payable at the end of each year the interest rate implicit
in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the
commencement date is 6% p.a. At the beginning of Year 6, Lessee and Lessor agree to
amend the original lease to reduce the space to only 2,500 square meters of the original
space staring from the end of the first quarter of Year 6. The annual fixed lease payments
(from Year 6 to Year 10) are ` 30,000. Lessee’s incremental borrowing rate at the beginning
of Year 6 is 5% p.a.
How should the said modification be accounted for?

  QUESTION 36

Modification that is a change in consideration only

Lessee enters into a 10-year lease for 5,000 square metres of office space. At the
beginning of Year 6, Lessee and Lessor agree to amend the original lease for the
remaining five years to reduce the lease payments from `1,00,000 per year to `95,000
per year. The interest rate implicit in the lease cannot be readily determined. Lessee’s
incremental borrowing rate the commencement date is 6% p.a. Lessee’s incremental
borrowing rate at the commencement date is 6% p.a. Lessee’s incremental borrowing rate
at the beginning of year 6 is 7% p.a. The annual lease payments are payable at the end of
each year.
How should the said modification be accounted for?
 INDIAN ACCOUNTING STANDARD 116: LEASES 245

  QUESTION 37

Modification that both increases and decreases the scope of the lease
Lessee enters into a 10-year lease for 2,000 square metres of office space. The annual
lease payments are ` 1,00,000 payable at the end of each year. The interest rate implicit
in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the
commencement date is 6%p.a.
At the beginning of Year 6, Lessee and Lessor agree to amend the original lease to:

a) include an additional 1,500 square metres of space in the same building starting
from the beginning of Year 6and
b) reduce the lease term from 10 years to eight years. The annual fixed payment for
the 3,500 square meters is `1,50,000 payable at the end of each year (from Year 6
to Year 8). Lessee’s incremental borrowing rate at the beginning of Year 6 is 7%p.a.
The consideration for the increase in scope of 1,500 square metres of space is not
commensurate with the stand-alone price for that increase adjusted to reflect the
circumstances of the contract. Consequently, Lessee does not account for the increase in
scope that adds the right to use an additional 1,500 square metres of space as a separate
lease.
How should the said modification be accounted for?

STEP V: PRESENTATION
ROU Asset and lease liabilities are subject to the same considerations as other assets and
liabilities in classifying them as current and non-current in the balance sheet. The following
table depicts how lease-related amounts and activities are presented in lessees financial
statements:

Balance Sheet Statement of profit or Statement of cash flows

loss
ROU Assets: Depreciation and Principal portion of the
They are presented either: interest: lease liability:
Separately from other Depreciation on Right of
-  - 
These cash payments are
assets (e.g., owned assets) use asset and interest presented within financing
OR expense accreted on activities
lease liabilities are Interest portion of the lease
presented separately liability
(i.e. they CANNOT be - 
These cash payments are
combined). presented within financing
activities
246 INDIAN ACCOUNTING STANDARD 116: LEASES

- 
Together with other This is because interest Short –term leases and
assets as if they were expense on the lease leases of low -value assets:
owned, with disclosures liability is a component - 
Lease payments
of the balance sheet line of finance costs. Which pertaining to them (i.e.,
items that include ROU paragraph 82(b) of Ind not recognised on the
Assets and their amounts AS 1 Presentation of balance sheet as per Ind
ROU Assets that meet the Financial Statements AS 116) are presented
definition of investment requires to be presented within operating activities
property are presented as separately in the
Variable lease payments
investment property statement of profit or
not included in the lease
loss.
Lease Liabilities: liability:
The are presented either: - 
These are also presented
- 
Separately from other within operating activities
liabilities OR - Non- cash activity:
- 
Together with other Such activity is disclosed
liabilities with disclosure as supplemental non-cash
of the balance sheet item (e.g., the initial
line items that includes recognition of the lease
lease liabilities and their at commencement)
amounts

STEP VI: DISCLOSURE

Disclosure objective:
The objective of the disclosures is for lessees to disclose information in the notes that,
together with the information provided in the balance sheet, statement of profit and loss
and statement of cash flows, gives a basis for users of financial statement s to assess the
effect that leases have on the financial position, financial performance and cash flows of
the lessee.
Ind AS 116 requires lessess to present All disclosures in:
- A single note OR
- Separate section in the financial statements.
 INDIAN ACCOUNTING STANDARD 116: LEASES 247

Quantitative Disclosure Requirement

Balance Sheet Statement of profit and Loss Statement of Cash
Flows
- Additions to right-of - Depreciation for assets by class. - Total cash outflow
use assets. - Interest expense on lease for leases.
- Carrying value of right- liabilities
of use assets at the end - Short-term leases expensed.
of the reporting period
- Low-value leases expenses.
by class.
- Income from subleasing.
- Maturity analysis
of lease liabilities - Gains or losses arising from sale
separately from other and leaseback transactions.
liabilities based on Ind
AS 107 requirements.

*These disclosures need not include leases with lease terms of one month or less.
All of the above disclosures are requires to be presented in tabular format, unless another
format is more appropriate. The amounts disclosed include costs that a lessee has included
in the carrying amount of another asset during the reporting period.
Other disclosure requirements also include:
♦ Commitments for short-terms leases if the current period expense is dissimilar to
future commitments.
♦ For right- of use assets that meet the definition of investment property, the disclosure
requirements of Ind AS 40, Investment property, with a few exclusions.
♦ For right –of use assets where the revaluation model has been applied, the disclosure
requirement of Ind AS 16, Property, plant and equipment.
♦ Entities applying the short-term and/or low value lease exemption are required to
disclose the fact.

Qualitative Disclosuer Requirements

- A summary of the nature of the entity’s leasing activates;
- 
Potential cash outflows the entity is exposed to the are not included in the measured
lease liability, including
- Variable lease payments;
- Extension options and termination options;
- Residual value guarantee, and
248 INDIAN ACCOUNTING STANDARD 116: LEASES

- Leases not yet commenced to which the lessee is committed.

- Restrictions or covenants imposed by leases; and
- Sale and lease back transaction information.

CONCEPT 10: LESSOR ACCOUNTING

A lessor is defined as an entity that provides the right to use an underlying asset for a
period of time in exchange for consideration.
At inception, lessors classify all leases as FINANCE LEASE or OPERATING LEASE. Lease
classification is very important because it determined how and when a lessor recognizes
lease income and what assets are recorded. Classification is based on the extent to which
the risk and rewards incidental to ownership of the underlying asset lie with the lessor or
the lessee. it depends on the substance of the transaction rather than the form of the
contract.
Where, a finance lease’ is defined as a lease that transfers substantially all the risks and
rewards incidental to ownership of an underlying asset.
Where, an operating lease’ is defined as a lease that does not transfer substantially all
the risks and rewards incidental to ownership of an underlying asset.
Ind AS 116 lists a number of examples that individually ,or in combination , would normally
lead to a lease being classified FINACE LEASE:

• the lease transfers ownership of the asset to the lessee by the

Ownership
end of the lease term

• The lessee has the option to purchase the asset at a price that is
expected to be sufficiently lower than the fair value at the date
Purchase option
the option become exercisable for it to be reasonably certain, at
the inception date, that the option will be exercised

• The lease term is for the major part of the economic life of the
Lease term
asset even if title is not transferred

PV of Minimum • At the inception date, the present value of the lease payment
Lese Payments amounts to at least substantially all of the fair value of the asset
 INDIAN ACCOUNTING STANDARD 116: LEASES 249

Speciallised • The asset is of such a specialised nature that only the lessee can
Nature use it without major modifications

Additionally, Ind AS 116 lists the following indicators of situations that, individually or in
combination. Could also lead to a lease being classified as a FINACE LEASE:

Loss on • If the lessee can cancel the lease, the lessor’s losses associated
cancellation with the cancellation are borne by the lessee

• Gains or losses from the fluctuation in the fair value of the

Risk of fair
residual accrue to the lessee (e.g., in the form of a rent rebate
value of the
that is equal to most of the sale proceeds at the end of the
residual asset
lease)

Option to • The lessee has the ability to continue the lease for a secondary
extend lease period at a rent that is substantially lower than market rent

Other considerations that could be made in determining the economic substance of the
lease arrangement include the following:

• Are the lease rentals based on a market rate for use of the asset (which would indicate
an operating lease) or a financing rate of use of the funds, which be indicative of a
finance lease?
• Is the existence of put and call options a feature of the lease? If so, are they exercisable
at a predetermined price or formula (indicating a finance lease) or are they exercisable
at the market price at the time the option is exercised (indicating an operating lease)?

Lease classification test for land and buildings:

For a lease that includes both land and buildings elements, the lessor separately assesses
the classification of each element as a finance lease or an operating lease, having fact
that land normally has an indefinite economic life.
The lessor allocated lease payments between the land and the buildings elements in
proportion to the relative fair values of the leasehold interest in the land element and
buildings element of the lease at the inception date, if the lease payments cannot be
allocated reliably between these two elements, the entire lease is classified as a finance
lease, unless it is clear that both elements are operating leases, in which case, the entire
lease is classified as an operating lease.
250 INDIAN ACCOUNTING STANDARD 116: LEASES

For a lease of land and building in which the amount for the land element is immaterial to
the lease, the lessor may treat the land and buildings as single unit for the purpose of
lease classification and classify it a s fiancé lease or an operating lease. Ind such a case,
the lessor regards the economic life of the buildings as the economic life of the entire
underlying asset.
Residual value guarantees included in the lease classification test:
In evaluating Ind AS 116’s lease classification criteria, lessors are required to include in the
substantially all test any (i.e., the maximum obligation ) residual value guarantees provided
by both lessees and any other third party unrelated to the lessor.
Reassessment of lease classification:
Lessors are required to reassess the lease classification only if there is a lease modification
(i.e., a change in the scope of a lease, or the consideration for a lease, that was not part
of the original terms and conditions of the lease). Lessors reassess lease classification as
at the effective date of the modification using the modified conditions at that date if a
lease modification results in a separate new lease, that new lease would be classified in the
same manner as any new lease.
Key concepts applied by the lessor:
Gross investment in the lease in the SUM of:
(a) the lease payments receivable by a lessor under a finance lease; AND
(b) Any unguaranteed residual value accruing to the lessor.
‘Net investment in the lease’ is the gross investment in the lease discounted at the
interest rate implicit in the lease.
Unguaranteed residual value is that portion of the residual value of the underlying asset,
the of which by a lessor is not assured or is guaranteed solely by a party related to the
lessor.
 INDIAN ACCOUNTING STANDARD 116: LEASES 251

UNIT 1: FINANCE LEASES

RECOGNITION
At the commencement date, a lesser shall recognise assets held under a finance lease in
its balance sheet and present them as a receivable at an amount equal to the net investment
in the lease.

INITIAL MEASUREMENT
At lease commencement, a lessor accounts for a fiancé lease, as follows:

Derecognises the carrying amount of the underlying asset

Recognises the net investment in the lease
Recognises, in profit or loss, any selling profit or selling loss

For finance leases other than those involving manufacturer and dealer lessors), initial direct
costs are included in the initial measurement of the fiancé lease receivable. Initial direct
costs are included in the lease, and are not added separately to the net investment in lease.

The present the present value of

value of lease the unguaranteed
payments residual value

Any selling profit or loss in measured as the difference between the fair value of the
underlying asset or the lease receivable, if lower, and the carrying amount of the underlying
asset, net of any undgranteed residual asset.

INITIAL MEASUREMENT MANUFACTURER OR DEALER LESORS

At the commencement date, a manufacturer or dealer lessor recognizes selling profit or
loss in accordance with its policy for outright sales to which Ind AS 115 applies.
Therefore, at lease commencement, a manufacture or dealer lessor recognizes the following

The fair value of the underlying asset as revenue OR the present value of the lease
payments disclosed using a market rate of interest, whichever is lower.

The cost (or carrying amount ) of the asset (less) the present value of the ungaranteed
residual value, as cost of sale.

The selling profit or loss in accordance with the policy for outright sales.
252 INDIAN ACCOUNTING STANDARD 116: LEASES

AT the commencement date, a manufacturer or dealer lessor recognizes selling profit or

loss on a finance lease, regardless of whether the lessor transfers the underlying asset as
described under Ind AS 115. Costs incurred by a manufacturer or dealer lessor in connection
with obtaining a finance lease are recognised as an expense at the commencement date and
are excluded from the net investment in the lease because they are mainly related to
related to earning the manufacturer or dealer s selling profit.
Accounting for initial direct costs shall be done in the following manner:

By Lessor
Finance Lease:
Ind AS 116 requires lessors (other than manufacturer or dealer lessors )ot include initial
direct costs in the initial measurement of their net investments in finance leases and
reduce the amount of income recginnised over the lease term.
The interest rate implicit in the lease is defined in such a way that the initial direct costs
are included automatically in the net investment in the lease and they are not added
separately. (initial direct costs related to finance leases incurred by manufacturer or
dealer lessors are expenses at lease commencement).
Operating Lease:
Ind AS 116 requires lessors to include initial direct costs in the carrying amont of the
underlying asset in an operating lease. These initial direct costs are recognizes as an
expense over the lease term on the same basis as lease income.

SUBSEQUENT MEASUREMENT
After lease commencement, a lessor accounts for a fiancé lease, as follows:

♦ Recognises finance income in profit or loss) over the lease term in amount that produces
a constant periodic rate of return on the remaining balance of the net investment in
the lease (i.e., using the interest rate implicit in the lease).
• Income is recognised on the components of the net investment in the lease, which
is interest on the lease receivables.
♦ Reduces the net investment in the lease for lease payments received (net of finance
income calculated above)
♦ Separately recognises income from variable lease payments that are not included in
the investment in the lease (e.g., performance – or usage – based variable payments) in
the period in which that income is earned
♦ Recognises any impairment of the net investment in the lease
 INDIAN ACCOUNTING STANDARD 116: LEASES 253

REMEAUREMENT OF THE NET INVESTMENT IN THE LEASE

After lease commencement, the investment in a lease in NOT REMEASURED UNLESS in
either of the following situations:
♦ The lease in modified (i.e., a change in the scope of the lee, or the consideration for
that lease, that was not part of the original terms and conditions of the lease) and
modified lease is not accounted for as a separate contract
OR
♦ The lease term is revised when is a change in the non-concellable period of the lease.
(Refer section 3.5.4 Modification of lease)

  QUESTION 38

Lessor accounting for a finance lease - dealer-lessor case

A Lessor enters into a 10-year lease of equipment with Lessee. The equipment is not
specialized in nature and is expected to have alternative use to Lessor at the end of the
10-year lease term. Under the lease:

• Lessor receives annual easy payments of`15,000,payable at the end of the year
• Lessor expects the residual value of the equipment to be `50,000 at the end of the
10-year lease term
• Lessee provides a residual value guarantee that protects Lessor from the first
`30,000
• The equipment has an estimated remaining economic life of 15 years, a carrying
amount of ` 1,00,000 and a fair value of ` 1,11,000
• The lease does not transfer ownership of the underlying asset to Lessee at the end
of lease term or contain an option to purchase the underlying asset
• The interest rate implicit in the lease is10.078%.
How should the Lessor account for the same in its books of accounts?

IMPAIRMENT OF THE NET INVESTMENT IN THE LEASE:

A lessor shall apply the derecognition and impairment requirement in Ind AS 109 to the net
investment in the lease. A lessor shall review regularly estimated unguaranteed residual
values used in computing the gross investment in the lease. If there has been a reduction in
the estimated unguaranteed residual value the lessor shall revise the income allocation over
the lease term and recognise immediately any reduction in respect of amounts accrued.
254 INDIAN ACCOUNTING STANDARD 116: LEASES

UNIT II: OPERATING LEASES

RECOGNITION AND MEASUREMENT

A lessor shall recognise lease payments from operating leases as income on either a straight-
line basis OR another systematic basis. The lessor shall apply another systematic if that
basis is more representative of the pattern in which benefit derived from the use of the
underlying asset is diminished.
Lessors subsequently recognize lease payments over the lease term on either a straight-
line basis or another systematic and rational basis if that basis better represents the
pattern in which benefit is expected to be derived from the use of the underlying asset.
After lease commencement, lessors recognise variable lease payments that do not depend
on an index or rate (e.g., performance – or usage-based payments) as they are earned.
In AS 116 also requires lessors of operating leases to defer initial direct costs at lease
commencement and recognize them over the lease term on the some basis as lease income.

UNIT III: LEASE MODIFICATIONS

A lease modification is a change in the scope of a lease, or the consideration for a lease,
that was not part of the original terms and conditions of the lease (for e.g., adding or
terminating the right to use one or more underlying assets or extending or shortening the
contractual lease term).

FINANCE LEASE MODIFICATION

A lease modification is accounted for as a separate lease if both:

(a) The modification increases the scope of the adding the right to use or more underlying
assets’ and
(b) The consideration for the lease increases by an amount commensurate with the
standalone price for the increase in scope.
If both criteria are met, a lessor would follow the exiting lessor guidance on initial recognition
and measurement.

The lease would

• Account for the lease modification as a new lease from the
have been
effective date of the modification; and
classified as
• Measure the carrying amount of the underlying asset as the
operating with the
net investment in the lease immediately before the effective
modifications at
date of the lease modification.
the inception date
 INDIAN ACCOUNTING STANDARD 116: LEASES 255

MODIFICATION – NOT SEPARATE LEASE:

If a lease modification fails the test to be considered as separate lese as mentioned above,
the lessor follows the following guidance;

All other lease

• Apply the requirements of Ind AS 109 Financial Instrument
modification

The re-measurements above occur as of the effective date of the lease modification on a
prospective basis.

OPERATING LEASE MODIFICATION

A lessor shall account for a modification to an operating lease as a new lease from the
effective date of the modification, considering any prepaid or accrued lease payments
relating to the original lease as part of the lease payments for the new lease.

UNIT IV: PRESENTATION

Lessors have the following presentation requirements under Ind AS 116, depending on the
classification of leases:

Finance Leases Operating Leases

Lessors recognize assets held under a finance Lessors are required to present
lease in the balance sheet and present them underlying assets subject to operating
as a receivable at an amount equal to the net leases according to the nature of that
investment in the lease under Ind AS 116. asset in the balance sheet under Ind
In addition, the net investment in the lease is AS 116.
subject to the same considerations as other
assets in classification as current or non-
current assets in a classified balance sheet.

DISCLOSURE
The objective of the disclosure requirements for lessors to disclose information in the
notes that together with information provided in the balance sheet, statement of profit or
loss and statement of cash flows, gives a basis for users of financial statement to assess
the effect that leases have on the financial position, financial performance and cash flows
of the lessor.
256 INDIAN ACCOUNTING STANDARD 116: LEASES

The lessor disclosure requirements in Ind AS 116 are more extensive to enable users of
financial statements to better evaluate the amount, timing and uncertainty of cash flows
arising from a lessor’s activities.

Quantitative Disclosure Requirements

Finance leases - Selling profit or loss.
- Finance income on the net investment;
- Income from variable lease payments;
- Qualitative and quantitative explanation of changes in the net
investment; and
- Maturity analysis of lease payments receivable
Operating leases - Lease income, separately disclosing variable lease payments;
- 
Disclosure requirements of Ind AS 16 for leased asset,
separating leased assets from non-leased assets;
- 
Other applicable disclosure requirements based on the nature
of the underlying asset (e.g. Ind AS 36, Ind AS 38, AS 40 and
Ind AS 41); and
- Maturity analysis of lease payments
 INDIAN ACCOUNTING STANDARD 116: LEASES 257

CONCEPT 11: SUB-LEASES

Recognition and Measurement

A Sub-lease is defined as a transaction for which an underlying asset is re-leased by a
lessee (intermediate lessor) to a third party, and the lease (‘head lese’) between the head
lessor and lessee remains in effect.
Lessees often enter into arrangements to sublease a leased asset to a third party while
the original lease contract is in effect, where, one party acts as both the lessee and lessor
of the same underlying asset. The original lease is often referred to as a head lease’ the
original lessee is often referred to as an intermediate lessor or sub-lessor and the ultimate
lessee is often referred to as the sub lessee
It can be demonstrate with help of a following simple diagram:

Lessor
Sub Head
Original Lessee/intermediate lessor
Lease lease
Lessee/Sub-lessee

In some cases, the sublease is a separate lease agreement while, in other cases, a third
party assumes the original lease but, the original lessee remains the primary under the
original lease.
Intermediate Lessor Accounting:
Where an underlying asset is re-leased by a lessee to a third party and the original lessee
retain the primary obligation under the original lease, the transaction is a sublease, i.e.,
the originallessee generally continues to account for the original lease (the head lease) as a
lessee and accounts for the sublease as the lessor (intermediate lessor).
When the head lease is a short-term lease, the suble3ase is classified as an operating lease.
Otherwise, the sublease is classified using the classification criteria (as discussed earlier)
BUT, it should be by reference to the ROU Asset in the head lease (and NOT the underlying
asset of the head lease). This can be understood better with help of a following illustration:

  QUESTION 9

Classification of a sublease in case of an Intermediate Lessor

Entity ABC (original lessee/intermediate lessor) leases a building for five years. The
building has aneconomiclifeof40years.EntityABCsubleasesthebuildingforfouryears.
How should the said sublease be classified by Entity ABC?
258 INDIAN ACCOUNTING STANDARD 116: LEASES

SOLUTION:
The sublease is classified with reference to the ‘ROU Asset’ in the head lease (and NOT
the ‘underlying building’ of the head lease). Hence, when assessing the useful life criterion,
the sublease term of four years is compared with five-year ROU Asset in the head lease
(NOT compared with 40-year economic life of the building) and accordingly may result in
the sublease being classified as a finance lease.
The intermediate lessor accounts for the sublease as follows:

IF THE SUBLEASE IS CLASSIFIED } IF THE SUBLEASE IS CLASSIFIED

AS FINANCE LEASE’ AS AN OPERATING LEASE’
The original lessee derecognizes the ROU The original lessee continues to accounts
Asset on the head lease at the sublease for the lease liability and ROU asset on the
commencement date and continues to head lease like any other lease.
account for the original lease liability inIf the total remaining carrying amount of
accordance with the lessee accounting the Rou asset on the head lease exceeds
model. the anticipated sublease income, this may
The original lessee (as the intermediate indicate that the ROU asset associated
lessor) recognizes a net investment in the with the head lease is impaired (which is
sublease and evaluates it for impairment. assessed for impairment under Ind AS 36).

  QUESTION 40

Intermediate Lessor – Where the sublease is classified as a ‘Finance Lease’

Head lease:
An intermediate lessor enters into a five-year lease for 10,000 square metres of office
space (the head lease) with Entity XYZ (the head lessor).
Sublease:
At the beginning of Year 3, the intermediate lessor subleases the 10,000 square metres of
office space for the remaining lease term i.e., three years of the head lease to a sub-lessee.
How should the said sublease be classified and accounted for by the Intermediate Lessor?

SOLUTION:
The intermediate lessor classifies the sublease by reference to the ROU Asset arising
from the head lease (i.e., in this case, comparing the three-year sublease with the five-year
ROU Asset in the head lease). The intermediate lessor classifies the sublease as a finance
lease, having considered the requirements of Ind AS 116 (i.e., one of the criteria of ‘useful
life’ for a lease to be classified as a finance lease).
 INDIAN ACCOUNTING STANDARD 116: LEASES 259

When the intermediate lessor enters into a sublease, the intermediate lessor:

(i) Derecognizes the ROU asset relating to the head lease that it transfers to the
sublessee and recognises the net investment in the sublease;
(ii) Recognises difference between the ROU asset and the net investment in the
sublease in profit or loss, AND
(iii) Retains the lease liability relating to the head lease in its balance sheet, which
represents the lease payments owed to the head lessor.

During the term of the sublease, the intermediate lessor recognises both

 finance income on the sublease AND

 Interest expense on the head lease.

  QUESTION 41

Intermediate Lessor – Where the sublease is classified as a‘ Operating Lease’

Head lease:
An intermediate lessor enters into a five-year lease for 10,000 square metres of office
space (the head lease) with Entity XYZ (the head lessor).
Sublease:
At the commencement of the head lease, the intermediate lessor subleases the 10,000
square metres of office space for two years to a sub-lessee.
How should the said sublease be classified and accounted for by the Intermediate Lessor?

SOLUTION:
The intermediate lessor classifies the sublease by reference to the ROU Asset arising
from the head lease (i.e., in this case, comparing the two-year sublease with the five-
year ROU Asset in the head lease). The intermediate lessor classifies the sublease as
an operating lease, having considered the requirements of IndAS 116 (i.e., one of the
criteria of ‘useful life’ for a lease to be classified as a finance lease and since, it is not
satisfied, classified the same as an operating lease).
When the intermediate lessor enters into the sublease, the intermediate lessor retains:

- the lease liability AND

- the ROU Asset
both relating to the head lease in its balance sheet.
260 INDIAN ACCOUNTING STANDARD 116: LEASES

During the term of the sublease, the intermediate lessor:

(a) recognises a depreciation charge for the ROU asset and interest on the lease
liability; AND
(b) recognises lease income from the sublease.

CONCEPT 11: SALE AND LEASEBACK TRANSACTIONS

A sale and leaseback transaction involves the transfer of an asset by an entity (the
seller-lessee) to another entity (the buyer-lessor) and the leaseback of the same asset
by theseller-lessee.
Sale and leaseback transactions would no longer provide lessees with a source of off-
balance sheet financing because under Ind AS 116, lessees are required to recognise
most leases on the balance sheet (i.e., all leases except for leases of low-value assets
and short-term leases depending on the lessee’s accounting policy lection).
Further, both the seller-lessee and the buyer-lessor are required to apply Ind AS 115 to
determine whether to account for a sale and leaseback transaction as a sale and purchase
of an asset.

Transactions in which the transfer of an asset is a SALE

If the transfer of an asset by the seller-lessee satisfied the requirments of Ind AS 115 to
be accounted for as a sale of the asset:

Seller-lessee Buyer-lessor
The seller-lessee shall measure the ROU asset The buyer-lessor shall account for
arising from the leaseback at the proportion of the purchase of the asset, applying
the previous carrying amount of the asset that applicable Ind AS and for the lease,
related to the right of use retained by the applying the lessor accounting
seller-lessee. Accordingly, the seller-lessee requirements under Ind AS 116.
shall recognise only the amount of any gain or
loss that relates to the rights transferred to
Thus, a buyer-lessor accounts for the
the buyer –lessor.
purchase of the asset in accordance
Thus, the seller-lessee will: with other Ind Ass based on the nature
- Derecognise the underlying asset of the asset (for e.g., Ind AS 16 for
-R
 ecgongnise the gain or loss, if any, that relates property, plant and equipment).
to the rights transferred to the buyer-lessor
(adjusted for off-market terms)
 INDIAN ACCOUNTING STANDARD 116: LEASES 261

When a sale occurs, both the seller-lessee and the buyer-lessor account for the leaseback
in the same as any other lease (with adjustment for any off-market terms). Specifically
a seller –lessee recognises a lease liability and ROU asset for the leaseback subject to
the optional exemptions for short-term leases and leases of low-value assets).

An entity shall make the following adjustments to measeure the sale proceeds at fair value
if:

- The fair value of the consideration for the sale of an asset not equal the fair value of
the asset OR
- The payments for the lease are not at market rates:
(a) Any below – market terms shall be accounted for as prepayments of lease payments;
AND
(b) any above – market terms shall be accounted for as an additional financing provided
by the buyer-lessor to the seller –lessee.
The entity shall measure any potential adjustment (‘a’ or ‘b’ as described above) on the basis
of the following (whichever is more readily determinable):

(a) The difference between the fair value of the consideration for the sale and the fair
value of the asset’ OR
(b) The difference between the present value of the contractual payments for the lease
and the present value of payments for the lease at market rates.
The sale transaction and the resulting lease are generally interdepended and negotiated
as a package. Consequently, some transactions could be structured with a negotiated
sales price that is above or below the asset’s fair value and with lease payments for the
resulting lease that are above or below the market rates. These off-market terms could
mislead/ falsify the gain or loss on the sale and the recognition of lease expense and lease
income for the lease. Thus, to ensure that the gain or loss on the sale and the lease-related
assets and liabilities associated with such transactions are NEITHER understated NOR
overstated, Ind AS 116 requires adjustments for any off-market terms of sale and
leaseback transactions, on the more readily determinable basis (as discussed above). Thus
the two possibilities of the sale price OR the present value of the lease payments being less
or greater than the fair value of the asset OR present Value of the market lease payments,
respectively is disclosed in detail:
262 INDIAN ACCOUNTING STANDARD 116: LEASES

When sale price or Present Value is When sale price or present Value is
LESS GREATER

Using the more readily determinable basis: Using the more readily determinable basis:
When the sale price is LESS than the When the sale price is GREATER than the
underlying asset’s fair value OR underlying asset’s fair Value or
The present value of the lease payments The present value of the lease payments is
is LESS than present value of the market GREATER than the present value of the
lease payments, market lease payments.
A seller-lessee recognizes the difference a seller-lessee recognizes the difference
as an increase to the sales price and the as reduction in the sales price and an
initial measurement of the ROU asset as a additional financing received’ from the
‘lease prepayment’. buyer-lessor.

Buyer-lessors are also required to adjust the purchase price of the underlying
asset for any off-market terms. Such adjustments are recognised as:
- ‘lease prepayments’ made by the seller-lessee OR
- ‘additional financing provided ’to the seller -lessee.

Let us consider an illustration to understand the accounting for a sale and leaseback
transaction:

  QUESTION 42

Sale and leaseback transaction

An entity (Seller-lessee) sells a building to another entity (Buyer-lessor) for cash of
`30,00,000. Immediately before the transaction, the building is carried at a cost of
`15,00,000. At the same time, Seller-lessee enters into a contract with Buyer-lessor for
the right to use the building for 20 years, with annual payments of `2,00,000 payable at
the end of each year.
The terms and conditions of the transaction are such that the transfer of the building by
Seller- lessee satisfies the requirements for determining when a performance obligation is
satisfied in Ind AS 115 Revenue from Contracts with Customers.
The fair value of the building at the date of sale is `27,00,000. Initial direct costs, if
any, are to be ignored. The interest rate implicit in the lease is 12% p.a., which is readily
determinable by Seller-lessee.
 INDIAN ACCOUNTING STANDARD 116: LEASES 263

Buyer-lessor classifies the lease of the building as an operating lease.

How should the said transaction be accounted by the Seller-lessee and the Buyer-lessor?

CONCEPT 12: TRANSITION APPROACH

An entity shall apply Ind AS 116 annual reporting periods beginning on or after 01 April
2019.
For the purpose of the requirements of this Transition’ section, the Date of initial
application is the beginning of the annual reporting period in which an entity first applies
Ind AS 116.
Thus, Ind AS 116,s Transition provisions are applied at the beginning of the annual reporting
period in which the entity first apples Ind AS 116 (i.e., the date of initial application). For
e.g., an entity with a reporting date of 31 March 2020, applies the transitions provisions on
10 April 2019

TRANSITION OPTIONS FOR LESSEES

A lessee is required to apply Ind AS 116 its leases in either of the following ways:

Full Retrospective Approach Modified Retrospective Approach

Retrospectively to each prior reporting period Retrospectively with cumulative
presented , applying Ind AS 8, i.e., an entity effect of initially applying Ind AS
applies Ind AS 116 as if it had been applied 116 recognise as an adjustment to the
since the inception of all lease contracts that opening balance of retained earnings
are presented in the financial statements. (or other component of equity, as
If Ind AS 116 is applied at 01 April 2019, this appropriate ) at the ate of the initial
means that, in the 31 March 2020 financial application, therefore, restatement of
statements , the comparative period to 31 comparatives is not required an only
March 2019 must be restated (assuming that Balance sheets for reporting date
this is the only comparative period presented. A and comparative date is required to be
restated opening balance sheet at 01 April 2018 presented
will also need to be discloses a required by Ind
AS 1. Hence the balance sheet for 3 period will
be presented: As at 31 March 2020, 31 March
2019 & 1 April 2018.

A lessee shall apply the elected transition approach consistently to ALL lessees in which it
is lessee.
264 INDIAN ACCOUNTING STANDARD 116: LEASES

MODIFIED RETROSPECTIVE APPROACH

LEASES PREVIOUSLY CLASSIFIED AS OPERATING LEASES
When applying the modified retrospective approach a lessee does not restante comparative
figures rather, a lessee recognises the cumulative effect of initially applying Ind AS 116 as
an adjustment to the opening balance of retained earnings (or other component of equity,
as appropriate) at the date of initial application.
For lessee previously classified as operating leases under Ind AS 17 a lessee recognises a
lease liability measured at the present value of the remaining lease payments, discounted
using the lessee’s incremental borrowing rate at the date of initial application. A lessee
measured the ROU asset on a lease-by lease basis,u at either
- Its carrying amount as if In AS 116 had allows been applied since the commencement
date, but using a discount rate based on the lessee’s incremental borrowing rate at the
date of initial application (Alternative 1)
- An amount equal to the lease liability, adjusted for previously recognises prepaid or
accrued lease payments (Alternative 2)
A lessee applies Ind AS 36 to ROU asset at the date of initial application unless the lessee
apples the practical expedient for onerous leases (as discussed below).
A lessee is not required to make adjustments on transition for leases of low-value assets
(which is one of the recognition exemptions under Ind AS 116-as discussed earlier).

LEASES PREVIOUSLY CLASSIFIED AS FINANCE LEASES

When applying modified retrospective approach, for leases that were classified as finance
leases applying Ind AS 17.the carrying amount of the ROU asset and the lease liability
at the date of initial application shall be the carrying amount of the lease asset and lease
liability immediately before that date measured applying Ind AS 17. For such leases, a
lessee shall account for the ROU asset and the lease liability applying Ind AS 116 from
the date of initial application. Thus a lessee will not change its initial carrying amounts for
assets and liabilities under finance leases existing at the date of initial application of Ind
AS 116.

Operating Lease Measure at the present value of the remaining lease

Lease liability payments, Discounted using lessee’s Incremental
borrowing rate at the date of initial application
Right – of – Retrospective calculation, using a discount rate based on
use asset lessee’s incremental borrowing rate at the date of initial
application.
Or
 INDIAN ACCOUNTING STANDARD 116: LEASES 265

Amount of lease liability (adjusted by the amount of any

previously recognised prepaid or accrued lease payments
relating to that lease).
Lessee can chose on of the
Alternatives on a lease-by lease basis.
Finance Lease Lease Carrying amount of the lease liability
liability Immediately before the date of initial application.

Right – of – Carrying amount of the lease asset immediately before the

use asset date of initial application

Application Apply the provisions of this standard to Right of use asset

Ind AS 116 and lease liability from date of initial application.

The standard also prescribes certain practical expedients under Modified retrospective
approach to leases previously classified as operating leases applying Ind AS 17.

  QUESTION 43

Transition Approaches
A retailer (lessee) entered into 3-year lease of retail space beginning at 1 April 2017
with three annual lease payments of `2,00,000 due on 31 March 2018, 2019 and 2020,
respectively. The lease is classified as an operating lease under Ind AS 17. The retailer
initially applies Ind AS 116 for the first time in the annual period beginning at 1 April
2019. The incremental borrowing rate at the date of the initial application (i.e., 1 April
2019) is 10% p.a. and at the commencement of the lease (i.e., 1 April 2017) was 12% p.a.
The ROU asset is subject to straight-line depreciation over the lease term. Assume that
no practical expedients are elected, the lessee did not incur initial direct costs, there
were no lease incentives and there were no requirements for the lessee to dismantle
and remove the underlying asset, restore the site on which it is located or restore the
underlyingassettotheconditionunderthetermsandconditionsofthelease.

What would be the impact for the lessee using all the following transition approaches: Full
Retrospective Approach
Modified Retrospective Approach

- Alternative1
- Alternative2
266 INDIAN ACCOUNTING STANDARD 116: LEASES

DISCLOSURE
Disclosure requirments vary in accordance with the Transition Approach opted. The lessee
shall disclose the following as required by Ind AS 8 (except that it is impracticable to
determine the amount of the adjustment):

Full Retrospective Approach Modified Retrospective Approach

(a) The title of the Ind AS: (a) The title of the Ind AS;
(b) When applicable that the change in (b) When applicable, that the change in
accounting policy is made in accordance accounting policy is made in accordance
with its transitional provisions: with its transitional provisions;
(c) The nature of the change in accounting (c) The nature of the change in accounting
policy; policy;
(d) When applicable, a description of the (d) When applicable, a description of the
transitional provisions; transitional provisions;
(e) When applicable the transitional (e) When applicable, the transitional
proviso ions that might have an effect provisions that might have an effect
on future periods; on future periods;
(f) For the current period and each (f) The weighted average lessee’s
prior period presented, to the extent incremental borrowing rate applied
practicable, the amount of the to lease liabilities recognises in the
adjustment: balance sheet at the date of initial
(i)  For each financial statement line application; and an explanation of any
item affected; and difference between;
(ii) 
If Ind AS 33 Earnings per Share (i) 
Operating lease commitments
applies to the entity , for and disclosed applying Ind AS 17 at
diluted earnings per share; the end of the annual reporting
period immediately preceding
(g) the amount of the adjustment relating
the date of initial application,
to periods before those presented, to
discounted using the incremental
the extent practicable; and
borrowing rate at the date of
(h) If retrospective application required
initial application; and
by Ind AS 8 is impracticable for
a particular prior period, or for (ii) lease liabilities recognises in the
balance sheet at the date of
periods before those presented,
initial application.
the circumstances that led to the
existence of that condition and a (g) The amount of the adjustment relating
description of how and from when the to periods before those presented, to
change in accounting policy has been the extent practicable; and
applied.
 INDIAN ACCOUNTING STANDARD 116: LEASES 267

(h) If retrospective application required

by Ind AS 8 is impracticable for
a particular prior period, or for
period before those presented,
the circumstances that led to the
existence of that condition and a
description of how and fro when the
change in accounting policy has been
applied.
Further, if a lessee uses one or more
of the practical expedients (already
discussed above), it shall disclose that
fact.

LESSORS
A lessor is not required to make any adjustments on transition for leases in which it is lessor
and shall account for those leases applying Ind AS 116 from the date of initial application

KEY DIFFERENCES BETWEEN IND AS 116 AND AS 19

The significant differences between Ind AS 116 and 19 are given below:

Sr. No. Particulars Ind AS 116 AS 19

1 Lease definition Under Ind AS 116, the Under Ind AS 116, the
definition of lease is similar definition of lease is similar
to that in AS19. But, in Ind to that in AS 19. However,
AS 116, there is substantial guidance part given therein
change in the guidance of is different.
how to apply this definition.
The changes primarily
relate to the concept of
‘control’ used in identifying
whether a contract contains
a lease or not.
268 INDIAN ACCOUNTING STANDARD 116: LEASES

2 Modifications: Ind AS 116 brings No such comprehensive

in comprehensive coverage is there
prescription on accounting
of modifications in lease
contracts.

3 Scope Ind AS 116 has no such AS 19 excludes leases of

scope exclusion land from its scope
Ind AS 116 makes a No such distinction has
distinction between been made in AS 19
‘inception of lease’ and
‘commencement of lease’

4 Classification Ind AS 116 eliminates AS 19 requires a lessee to

the requirement of classify leases as either
classification of leases as finance leases or operating
either operating leases or leases
finance leases for a lessee
and instead, introduces a
single lessee accounting
model which requires
lessee to recognise assets
and liabilities for all
leases unless it applies
the recognition exemption
applies.

5 Sale & In Ind AS 116. The approach As per AS 19, if a sale

Leaseback for computation of gain/ and leaseback transaction
transactions loss for a complete sale is results in finance lease,
different. excess, if any of the sale
The amount of gain/loss proceeds over the carrying
should reflect the amount amount sale be deferred
that relates to the right and amortised by the
transferred to the buyer- seller- term in proportion
lessor. to depreciation of the
leased asset.
INDIAN ACCOUNTING STANDARD 116: LEASES 269

6 Treatment of
initial direct
costs
Finance
lease lessor
accounting
Non- Either recognised as Interest rate implicit in
manufacturer/ expense immediately or the lease is defined in
Non-dealer allocated against the finance such a way that the initial
income over the lease term. direct costs included
automatically in the finance
lease receivable.
Manufacturer/ Recognised as expenses Same as per AS 19.
dealer immediately.

Operating Either deferred and Added to the carrying

lease-Lessor allocated to income over amount of the leased asset
accounting the lease term in proportion and recognised as expense
to the recognition of rent over the lease term on the
income, or recognized as same basis as lease income.
expense in the period in
which incurred

7 Initial direct Ind AS 116 contains clearer Different guidance given

costs definition of ‘initial direct
costs’
Further, definition of the
term ‘interest rate implicit in
the lease’ has been modified
in Ind AS 116.

8 Presentation As a consequence of Different guidance given

introduction of single lease
model for lessees, there
are many changes in the
presentation in the three
components of financial
statements viz. Balance
sheet, Statement of P&L,
Statement of Cash flows
270 INDIAN ACCOUNTING STANDARD 116: LEASES

9 Disclosure There are a number of Different guidance given

changes in the disclosure
relating to qualitative
aspects of leasing
transactions. For eg.
Entities are required to
disclose the natureand
risks arising from leasing
transactions. Also, in case
of lessor, there are changes
in the disclosure of maturity
analysis of leases payments
receivable.

MAJOR CHANGES UNDER IND AS 116 FROM IFRS 16

Ind AS 116, like other Ind ASs, has been converged from the global standards, i.e.,
IFRSs, which has been made applicable to the Indian entities (based on the net worth
criteria) in a phased manner via Ministry of Corporate Affairs Roadmap. While converging
from IFRS 16 (which is applicable globally from the reporting periods beginning on or
after 01 January 2019), following are the carve outs given under Appendix 1 to Ind AS
116, keeping in mind, the requirements of other converged Ind AS sand the economic
environment in india:

Sr. No. Particulars IFRS 16 Ind AS 116

1 Subsequent Paragraph 34 of IFRS Paragraph 34 has been deleted
measurement 16 provides that if under Ind AS 116 since Ind AS
of investment lessee applies fair
40 Investment Property does
property value model in IAS
NOT the use of fair value
40 to its investment
model. Consequently, reference
property, it shall
of the same appearing anywhere
apply that fair value
under Ind AS 116 has also been
model to the ROU
deleted.
assets that meet
the definition of
investment property.
INDIAN ACCOUNTING STANDARD 116: LEASES 271

2 Interest Paragraph 50(b) of Ind AS 7 requires interest

portion of IFRS 16 requires paid to be treated as financing
leaseliability to classify cash activity only Accordingly,
– payments for paragraph 50(b) has been
interest portion of modified under Ind AS 116 to
classification
lease liability applying specify that cash payments
in cash flow
requirements of for interest portion of lease
statement
IAS 7 Statement liability will be classified as
of Cash Flows. IAS financing activities applying
7 provides option of Ind AS7.
treating interest
paid as operating or
financing activity.
 272 INDIAN ACCOUNTING STANDARD 116: LEASES

(TEST YOUR KNOWLEDGE)

 QUESTIONS

1. A lessee enters into a ten-year contract with a lessor (freight carrier) to

transport a specified quantity of goods. Lessor uses rail wagons of a particular
specification, and has a large pool of similar rail wagons that can be used to
ful fil the requirements of the contract. The rail wagons and engines are
stored at lessor’s premises when they are not being used to transportgoods.
Costsassociatedwithsubstitutingtherailwagonsareminimalforlessor.
Whether the lessor has substantive substitutions rights and whether the
arrangement contains alease?
2. Customer M enters into a 20-year contract with Energy Supplier S to install, operate
and maintain a solar plant for M’s energy supply. M designed the solar plant before
it was constructed – M hired experts in solar energy to assist in determining the
location of the plant and the engineering of the equipment to be used. M has the
exclusive right to receive and the obligation to take any energy produced. Whether
it can be established that M is having the right to control the use of identified
asset?
3. A Customer enters into a ten-year contract with a Company (a ship owner) for
the use of an identified ship. Customer decides whether and what cargo will be
transported, and when and to which ports the ship will sail throughout the period of
use, subject to restrictions specified in the contract. These restrictions prevent
the company from sailing the ship into waters at a high risk of piracy or carrying
explosive materials. The company operates and maintains the ship, and is responsible
for safe passage.
Does the customer has the right to direct how and for what purpose the ship is to be
used throughout the period of use and whether the arrangement contains a lease?
4. A Lessee enters into a ten-year lease contract with a Lessor to use an equipment.
The contract includes maintenance services (as provided by lessor). The Lessor
obtains its own insurance for the equipment. Annual payments are `10,000 (`1,000
relate to maintenance services and `500 to insurance costs).
The Lessee is able to determine that similar maintenance services and insurance
costs are offered by third parties for `2,000 and `500 a year, respectively. The
Lessee is unable to find an observable stand-alone rental amount for a similar
equipment because none is leased without related maintenance services provided
by the lessor.
How would the Lessee allocate the consideration to the lease component?

5. A Lessee enters into a non-cancellable lease contract with a Lessor to lease a

building. Initially, the lease is for five years, and the lessee has the option to
extend the lease by another five years at the same rental.
To determine the lease term, the lessee considers the following factors:
♦ M
 arket rentals for a comparable building in the same area are expected to
increase by 10% over the ten-year period covered by the lease. At inception of
 INDIAN ACCOUNTING STANDARD 116: LEASES 273

the lease, lease rentals are in accordance with current market rents.
♦ Thelesseeintendstostayinbusinessinthesameareaforatleast20years.
♦ The location of the building is ideal for relationships with suppliers and customers.
WhatshouldbetheleasetermforleaseaccountingunderIndAS116?
6. A Lessee enters into a lease of a five-year-old machine. The non-cancellable lease
term is 15 years. The lessee has the option to extend the lease after the initial 15-
year period for optional periods of 12 months each at market rents.
To determine the lease term, the lessee considers the following factors:
♦ T
 he machine is to be used in manufacturing parts for a type of plane that the
lessee expects will remain popular with customers until development and testing
of an improved model are completed in approximately 15years.
♦ Thecosttoinstallthemachineinlessee’smanufacturingfacilityissignificant.
♦ T
 he non-cancellable term of lessee’s manufacturing facility lease ends in 19
years, and the lessee has an option to renew that lease for another twelve years.
♦ L
 essee does not expect to be able to use the machine in its manufacturing process
for other types of planes without significant modifications.
♦ Thetotalremaininglifeofthemachineis30years.
What should be the lease term for lease accounting under Ind AS 116?
7. A Company leases amanu facturing facility The lease payments depend on the number
of operating hours of the manufacturing facility, i.e., the lessee has to pay ` 2,000 per
hour of use. The annual minimum payment is ` 2,00,00,000. The expected usage per
year is 20,000hours.
Whether the said payments be included in the calculation of lease liability under Ind
AS 116?

 ANSWERS

1. In this case, the rail wagons are stored at lessor’s premises and it has a large pool of
similar rail wagons and substitution costs to be incurred are minimal. Thus, the lessor
has the practical ability to substitute the asset. If at any point, the same become
economically beneficial for the lessor to substitute the wagons, he can do so and
hence, the lessor’s substitution rights are substantive and the arrangement does not
containa lease.
2. In this case, the nature of the solar plant is such that all of the decisions about how
and for what purpose the asset is used are predetermined because:
– the type of output (i.e. energy) and the production location are predetermined in
the agreement; and
– when, whether and how much energy is produced is influenced by the sunlight
and the design of the solar plant.
Because M designed the solar plant and thereby predetermined any decisions about
how and for what purpose it is used, M is considered to have the right to direct the
 274 INDIAN ACCOUNTING STANDARD 116: LEASES

use. Although regular maintenance of the solar plant may increase the efficiency of
the solar panels, it does not give the supplier the right to direct how and for what
purpose the solar plant is used. Hence, M is having a right to control the use of
asset.
3. The customer has the right to direct the use of the ship because the contractual
restrictions are merely protective rights that protect the company’s investment in
the ship and its personnel. In the scope of its right of use, the customer determines
how and for what purpose the ship is used throughout the ten-year period because
it decides whether, where and when the ship sails, as well as the cargo that it will
transport.
The customer has the right to change these decisions throughout the period of use
and hence, the contract contains a lease.
4. The observable stand-alone price for maintenance services is `2,000. There is no
observable stand-alone price for the lease. Further, the insurance cost does not
transfer a goodorservicetothelesseeandtherefore,itisnotaseparateleasecomponent.
Thus, the Lessee allocates ` 8,000 (` 10,000 – ` 2,000) to the lease component.
5. After considering all the stated factors, the lessee concludes that it has a significant
economic incentive to extend the lease.
Thus, for the purpose of lease accounting under Ind AS 116, the lessee uses a lease
term of ten years.

6. The lessee notes that the terms for the optional renewal provide no economic
incentive and the cost to install is significant. The lessee has no incentive to make
significant modifications to the machine after the initial 15-year period. Therefore,
the lessee does not expect to have a business purpose for using the machine after
the non-cancellable lease term of 15years.
Thus, the lessee concludes that the lease term consists of the 15-year non-cancellable
period only.
7. The said lease contains in-substance fixed payments of `2,00,00,000 per year,
which are included in the initial measurement of the lease liability under IndAS116.
However, the additional `2,00,00,000 that the company expects to pay per year are
variable payments that do not depend on an index or rate and, thus, are not included
in the initial measurement of the lease liability but, are expensed when the over-use
occurs.