Under Ind AS 116, most leases must be recognised on the balance sheet. The earlier distinction between finance and operating leases no longer exists for lessees. Most leases now result in recognition of a Right-of-Use (ROU) asset and a corresponding lease liability, increasing both reported assets and liabilities.

For companies finalising FY 2025-26 accounts, three implications deserve particular attention.

The Two Exemptions

  • Short-term leases with a term of 12 months or less at the commencement date and no purchase option.
  • Leases of low-value assets such as laptops, personal computers, and small office furniture. The assessment is made on an absolute basis per asset, not relative to the size of the company.

Where these exemptions are elected, lease payments are generally expensed on a straight-line basis over the lease term.

The EBITDA Impact Most Boards Miss

Under Ind AS 116, operating lease rental expense disappears from the income statement. It is replaced by depreciation on the ROU asset and interest on the lease liability. Since neither is deducted in arriving at EBITDA, reported EBITDA increases mechanically.

This does not represent an improvement in underlying performance. Boards and audit committees that use EBITDA as a key performance metric should understand what is driving any increase before attributing it to operational improvement.

The Debt Covenant Risk

Where banking covenants are tied to ratios such as debt-to-equity, interest coverage, or net debt-to-EBITDA, recognising lease liabilities as debt can cause a technical breach without any change in underlying financial position or borrowing behaviour.

Companies negotiating new borrowing facilities should also confirm whether lenders are using Ind AS-adjusted or pre-Ind AS covenant definitions.

Before FY 2025-26 Accounts Are Signed Off

Companies should confirm:

  • All leases, including embedded leases within service and outsourcing contracts, have been identified.
  • Discount rates are fixed at lease commencement and revised only on specific remeasurement events such as lease modifications or changes in lease term. Rates applied at transition should not be carried forward unchanged where subsequent events require remeasurement under Ind AS 116.
  • Disclosures, including the maturity analysis of lease liabilities and significant judgements relating to extension and termination options, are complete before accounts are signed off.

It is worth noting that while EBITDA typically improves, profit after tax may not improve in the early years of a lease, as depreciation and interest expense are generally front-loaded relative to a straight-line lease charge.