Executive Summary
Since April 2019, due to the introduction of IFRS 16 / Ind AS 116 – Leases, there has been a significant change in the way leases are accounted for, especially by the lessees. As per the earlier leasing standard, lessees were required to account for lease transactions as operating or finance lease depending on the rules and tests of classification. As per the new leasing standard, this classification is done away with, and lessees are now required to recognize nearly all leases (except short-term and low value leases) on the Balance Sheet which will reflect their Right-to-use an asset for a period of time and the associated lease liability for rent payments.
The accounting of operating leases as per the earlier standard was relatively straightforward, which required lessees to recognize lease payments as operating lease expense on a straight-line basis over the lease term.
However, as per the new standard, Right-to-use’ an asset / Right of use asset (ROU Asset) and lease liability is recognized on lease commencement date. Subsequently, expense is recognized in the form of finance charge on lease liability and depreciation on ROU Asset.
This change requires lessees to:
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- Recognize ROU asset for the right to use the asset he obtains by virtue of a lease contract from a lessor. Lessee measures ROU asset based on calculation of lease liability. In addition to the value of lease liability, ROU asset may include pre-payments related to lease, transaction costs etc.
- Recognize corresponding lease liability at the present value for an amount payable to lessor over the lease term in future
- Depreciate ROU Asset on a straight-line basis over the lease tenure/ asset useful life, whichever is lower
- Subsequently measure the lease liability by charging finance cost and reduce it to the extent of rent payment
- Re-measure the carrying value of lease liability due to modification in lease contract and provide the effect of such re-measurement on a prospective basis
- Adjust ROU Asset based on re-measurement of lease liability
- Calculate impact of profit or loss in case of decrease on scope of contract or termination of lease contract.
Hence, it is imperative for lessee to maintain and update the lease calculations under IFRS 16 / Ind AS 116 to ascertain carrying values of lease liability and ROU Asset at the end of every reporting period and calculate finance charge and depreciation charge for every reporting period for the purpose of lease accounting.
These calculations generally require using a spreadsheet and if the lessee entity has more than a handful of leases, then creating, maintaining, and updating the lease calculations using spreadsheet poses significant challenges like:
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- Risk of incorrect formulae
- Difficulty in handling complex re-measurement, modification, and termination calculations
- User specific spreadsheet resulting in dependency on a specific person
- Lack of maker – checker concept
This blog aims to discuss these challenges which all the lessee entities should be aware of and be prepared to address them whenever they arise, to ensure accuracy of lease calculations and disclosures as per IFRS 16 / Ind AS 116 – Leases.
Significant challenges posed by lease calculations using spreadsheets
1. Risk of incorrect formulae
It is a known fact that spreadsheets are prone to manual formula errors which include but are not limited to:
- Incorrectly typed formulas, incorrect cell references, circular references.
- Copying formulas incorrectly which includes not adjusting cell references when copying formulas to different locations.
- Pasting values – which means pasting data without formulas and losing the dynamic nature of calculations and thereby losing the trail.
- Mishandling date formats, leading to incorrect calculations or sorting.
- Hidden Rows and Columns – Forgetting that hidden rows/columns affect calculations and graphs.
- Performance Issues – Complex calculations on large data sets can slow down the spreadsheet or even cause crashes.
- Complex Formulae are harder to understand and prone to errors.
- Lack of Documentation – Failing to add comments to explain formulas and calculations for future reference.
- Version Control – Managing multiple versions of a spreadsheet can lead to confusion and using outdated data.
2. Difficulty in handling complex re-measurement, modification, and termination calculations
Despite all the limitations with spreadsheet, the entity might decide to invest significant amount of time and efforts for preparation of a template to generate lease calculations required under IFRS 16 / Ind AS 116 – Leases. However, entities need to note that lease calculation is not a onetime activity.
Such spreadsheet template would only handle the calculations required at the inception of the lease contract. However, if the terms of the contract change during the lease tenure or if entity decides to foreclose the contract, it might result into re-measurement / modification / termination of the lease contract.
This requires re-measuring the existing carrying value of lease liability with corresponding adjustment in carrying value of the ROU Asset and calculating the revised finance and depreciation charge for the remaining lease tenure on a prospective basis.
Termination requires de-recognition of lease liability, ROU Asset and calculation of gain / loss on termination which is to be accounted for in Statement of Profit and Loss.
Building a template in spreadsheet to handle such complex scenarios and maintaining it perpetually may be challenging if the entity has more than handful of lease contracts which undergo modification in the contract terms.
3. User specific spreadsheet resulting in dependency on a specific person
The lease calculation template can be built in a spreadsheet with formulae, various links within worksheets and fields for entering lease details. However, such spreadsheet would always be user specific. The person who builds the template in spreadsheet would have all the knowledge about the formulae, links, etc., however, in absence of this person, it would be difficult for any other person to enter or update the lease details in spreadsheet and get accurate results from it given the complex nature of calculations.
Further, in absence of detailed handover, the new person might make inputs in the spreadsheet in a way the template is not designed to accept and get inaccurate results from spreadsheet.
Hence, such person specific dependency may result in delay in getting desired results and hamper overall productivity.
4. Lack of maker – checker concept
Spreadsheets lack the maker-checker concept which involves one person preparing the template, entering inputs, applying formulae and another person reviewing and approving it.
In absence of such review mechanism, the user inputs and formulae based calculations in the template might go unreviewed and manual errors which might exist in the spreadsheet may go unnoticed. Further, it is practically not feasible to review each cell in the spreadsheet to ensure accuracy of the formula.
Conclusion
IFRS 16 / Ind AS 116 – Leases requires complex calculations to derive the carrying values of lease liability, ROU Asset, finance charge on lease liability and the depreciation of ROU Asset and it could possibly be argued that spreadsheet is the most economical tool for these calculations.
However, before making this decision, entities must weigh in the costs and risks arising due to the above-mentioned challenges in lease calculations using the spreadsheets and the legal and financial impact it could have on the entities if the lease information in the financial statements is misstated due to inherent limitations of such spreadsheets.
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