Adopted by Indian companies in FY 2019-20, Ind AS 116 changed one fundamental aspect of lease accounting. And with this change, almost every lease now comes on your balance sheet.
Now we don’t have that old distinction between operating leases and finance leases for lessees.
Under this new model, you must recognise a Right-of-Use (ROU) asset and a lease liability for nearly all arrangements where you have the right to use an asset over time.
Under this new model, EBITDA has undergone more changes.
The rent expenses that used to be treated as operating expenses are no longer the same. Instead, now you get depreciation on the ROU asset. And this is above EBITDA, and interest on the lease liability, which is a financing cost below EBITDA. As a result, EBITDA rises.
Not because the business is doing better, but because the accounting has shifted costs to different lines. That is the intended outcome. Errors in how companies apply this standard, though, produce EBITDA numbers that are wrong, sometimes higher than they should be, sometimes lower.
There are these 5 errors that account for most of what goes wrong.
In this article, let’s have a look at 5 recognition errors we see the most. And we will have a detailed look into how each one distorts the picture.
What Ind AS 116 Does to EBITDA
Before we get to see through the errors, it helps to understand the intended accounting clearly. Under Ind AS 17, an operating lease produced this entry every month:
When Ind AS 116 came into effect, it did one thing with immediate consequences. For every P&L conversation, it moved lease costs off the operating expense line.
Previously, rent was just rent that was placed above EBITDA. But now under Ind AS 116, that same cost gets split.
In this one part flows through depreciation, and another part through finance charges. Now the cash out the door is unchanged. But your EBITDA number is now higher.
In the upcoming sections, we will have a detailed look at each of the five errors. 5 errors cause EBITDA to drift from even this intended baseline, sometimes overstating it, sometimes understating it, for reasons entirely disconnected from business performance.
Error 1: Misidentifying What Qualifies as a Lease
Companies treat a contract as a service agreement when it actually contains a lease, or vice versa. This is one major error companies make related to Ind AS 116.
Ind AS 116 requires a specific test to determine whether a contract is, or contains, a lease. And in this, the key question is whether the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
Control means the customer has both the right to obtain substantially all the economic benefits from the asset. And they have the right to direct how and for what purpose the asset is used.
Where companies go wrong is in contracts that bundle services with asset use.
Common examples include:
- Dedicated server hosting agreements
- Fleet management contracts with assigned vehicles
- Warehouse space agreements where the provider has no substitution right
- Equipment-on-hire contracts with fixed machinery at a specified location
If the supplier cannot substitute the asset and has no practical ability to redirect it, the arrangement likely contains a lease under Ind AS 116, regardless of what the contract calls itself.
When a lease is misclassified as a service, the entire payment stays above EBITDA as an operating expense. EBITDA is understated compared to what the standard requires.
Error 2: Getting the Lease Term Wrong, in Both Directions
This is the second error companies usually make and this one is trickier than it seems.
The lease term under Ind AS 116 is not just the non-cancellable period in the contract. Instead it includes optional extension periods the lessee is reasonably certain to exercise. That threshold is kept too high on purpose. Which is much higher than “probably.”
For example, let’s take a retail store. Five-year lease, two five-year renewals.
In case this company has invested heavily in fit-out. Then for them this location is irreplaceable, and leaving would mean writing off crores. Hence those renewals should be included in the lease term.
Saying it’s a five-year lease because the contract says so is hard to defend.
Going the other way is equally common. Folding in every optional period without real judgment inflates the ROU asset and liability from day one.
| Error | EBITDA Effect | Balance Sheet |
|---|---|---|
| Options ignored | Overstated | Both understated |
| All options blindly included | Understated | Both overstated |
| Correctly assessed | Accurate | Faithfully stated |
And here’s what almost no one has built into their processes, the reassessment obligation.
When something significant changes like a modification, a strategic decision, etc… The lease term must be revisited. Without a trigger for that, the numbers drift. Quietly, until an audit surfaces the gap.
Error 3: One Discount Rate. Applied to Everything.
Companies apply a generic corporate borrowing rate instead of computing a proper incremental borrowing rate.
And we have seen that’s what most companies do. They pull the rate from the most recent term loan and apply it everywhere. A two-year laptop lease and a twelve-year factory arrangement get the same number. They treat a rupee office lease and a USD data centre contract identically.
When the standard asks for the incremental borrowing rate, what the company would pay to borrow, over a similar term, with similar security, for an asset of comparable value.
It’s supposed to be specific. When the IBR is understated, the present value of the liability rises. Larger liability, larger ROU asset, higher depreciation, lower EBITDA.
Overstate it and things move the other way. Neither error corrects itself, it compounds forward through the effective interest unwind, period after period.
Error 4: Variable Payments, What Goes In, What Stays Out
We must note that not everything paid under a lease agreement is a lease payment.
Here is what goes into the liability:
- Fixed payments
- Index-linked escalations (CPI, WPI), included at the current index, remeasured when the index changes
And here is what stays out:
- Payments that’s tied to sales, usage, or output
In practice, Indian commercial leases cover all these things together.
A mall lease might have base rent, a WPI escalation, CAM charges, and a percentage-of-sales component. But all these will be in one document, sometimes one invoice line.
Hence classifying all these apart correctly requires reading the contract. Not the payment schedule.
Fold a revenue-linked component into the liability, overstated obligation from day one. Treat a WPI escalation as variable and exclude it, liability understated. Miss the remeasurement when an index escalation actually kicks in (a specific obligation under Ind AS 116.42), the liability goes stale.
The EBITDA effect depends on which direction the error runs, but the interest coverage ratio gets distorted either way.
Error 5: The Exemptions Are Narrow. They Get Stretched.
Two exemptions in Ind AS 116 let certain leases stay off-balance-sheet:
- Short-term leases – these are leased for a short period that’s less than 12 months. Elected by asset class, and applied consistently.
- Low-value assets – these assets are assessed individually, at the asset’s value when new. Laptops, small equipment, individual furniture.
Both are intentionally short and both regularly get applied too broadly.
The short-term exemption gets applied to arrangements where renewal is commercially very likely. In case a rolling month-to-month contract that has been running uninterrupted for four years is not a short-term lease (in any practical sense).
The low-value exemption gets applied to equipment fleets assessed as a group. Let me tell you that it does not work that way. Three hundred laptops means three hundred individual assessments. Each asset qualifies or it doesn’t. The portfolio can’t be assessed in aggregate.
When these exemptions are misapplied systematically, which happens, material obligations stay off the balance sheet and EBITDA ends up lower than correct application would produce.
When All Five Stack Up
We have seen that these errors rarely arrive alone.
A single company might simultaneously carry unidentified embedded leases, a lease term pulled straight from the contract, an IBR from 2019, and variable payments incorrectly classified. Each error compounds the others. The EBITDA distortion isn’t additive, it’s layered.
Errors in lease identification and exemption application generally suppress EBITDA. Errors in lease term, discount rate, and payment classification can push it in either direction.
In due diligence, debt financing, private equity, an IPO, lease schedules get examined closely now. Investors run their own Ind AS 116 numbers. A material gap creates a valuation problem and restatement exposure, surfacing at exactly the moment when restating is most disruptive.
What To Actually Do About It
- At contracting stage – run the lease identification test before signing outsourcing, logistics, and infrastructure contracts. Some drafting choices (like how substitution rights are structured) affect classification. Easier to get right upfront than to unwind later.
- On discount rates – IBRs from FY 2019-20 need a fresh look. Market conditions changed. A stale rate means a misstated liability, full stop.
- On reassessment – build a trigger into the process. Modifications, index changes, decisions on options, each of these requires a remeasurement. Without a documented process, the lease schedule grows less accurate every quarter.
Conclusion
Ind AS 116 is not a new standard anymore. Five years in, “we’re still figuring out the transition” is not a defensible position, especially when lease obligations are material to the balance sheet and EBITDA is a number people are making decisions against.
The five errors above are not edge cases. They show up in routine audits, in due diligence reviews, in financing conversations where someone on the other side of the table has run the numbers independently and arrived at a different figure. The gap is rarely trivial.
Getting lease accounting right doesn’t require mastering every paragraph of the standard. It requires asking three honest questions about your portfolio: have we actually identified every lease, are the measurements still current, and does anyone own the reassessment process. Most companies, if they’re being candid, cannot answer yes to all three.
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