Indian Accounting Standard 116 or Ind AS-116 has come into effect from April 1 and pertains to principles for recognition, presentation and disclosure of leases.
Financial costs are likely to climb further for airlines in the near term, with new accounting standards on leases set to create “significant volatility” in their profit and loss accounts. Indian Accounting Standard 116 or Ind AS-116 has come into effect from April 1 and pertains to principles for recognition, presentation and disclosure of leases.
The standard, notified by the corporate affairs ministry, would have a significant impact on various industries such as airlines, where aircraft operated are mostly on lease. It also comes at a time when the domestic airline industry is grappling with tough times due to rise in fuel prices, intense competition, financial issues and infrastructure woes.
Sandip Khetan, National Leader and Partner (Financial Accounting Advisory Services) at EY India, said that many aircraft leases are denominated in USD, which is likely to be a currency different from the functional currency of most domestic airline companies. “Ind AS requires foreign currency lease liabilities to be retranslated at each reporting date and resulting gain or loss is typically recognised in P&L (Profit & Loss). This will create significant volatility in the P&L of Indian airline companies,” he told PTI.
However, he noted that companies might wish to assess whether they are able to apply hedge accounting to address this volatility and reconsider their treasury strategy. In the airline industry, leasing of planes is a common practice rather than outright purchase and the new accounting standard requires entities to show all leases on their respective balance sheets.
With Ind AS 116, experts said that net income would be negatively impacted in the early years of operating lease arrangement on account of higher interest costs while there would be a positive impact in the later years of lease life cycle. Besides, there would be an impact on various key ratios of companies such as EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) and net income. Under the accounting standard, leases which were previously treated as operating leases would now be recognised on balance sheet.
“A lessee will recognise a ‘right-of-use asset’ and a corresponding ‘lease liability’. The consequence is that instead of lease rental recognised earlier, it will now recognise depreciation and interest expense in its Statement of P&L. This will lead to increase in EBITDA and an increase in interest expense in the P&L,” Khetan noted.
The new standard would not differentiate the accounting treatment that lessee is required to follow for operating or finance leases but generally, total costs related to lease arrangements are unlikely to change over its entire life cycle. There would be an impact in between different reporting periods over the total life cycle of the lease.
A Deloitte India spokesperson said Ind AS 116 would have an impact on key metrics of airline companies like EBITDA and Return on Capital Employed (ROCE). These companies would also have to assess the effect of these changes on other aspects like debt covenants for example, he added. Ind AS 116 provides an option to account for lease and non-lease components separately or combined.
“Airline industries will have to choose amongst these options for wet leases (an arrangement covering the hire of an aircraft including the provision of a flight crew) considering the consequential impact on assets and liabilities on the balance sheet and the resulting impact on profit and loss on the EBITDA, operating expenses, depreciation and interest cost.
“For an airline industry while aircraft are the obvious targets under this leasing standard, other ancillary assets for e.g. hangars and parking bays also need to be assessed from a perspective of lease assessment,” the spokesperson said. While Vistara and AirAsia India declined to comment on the Ind AS-116 impact, queries sent to SpiceJet, IndiGo and Air India remained unanswered.
“The new standard will require a company to do more than simply convert its existing operating lease commitments disclosure to reflect lease assets and liabilities. Its implementation could result in changes to the policies, processes, controls and IT systems that support lease accounting,” Khetan noted.