Lease Accounting
Why almost every Indian company's balance sheet quietly got bigger in 2019 — without it buying a single new asset.
In plain English
Imagine you run a clothing brand and, instead of buying showroom space, you sign a nine-year rent agreement for two hundred stores across the country. Every month you pay rent, and every month your accountant records it as a simple expense, filed away like an electricity bill. For decades that is exactly how leases were accounted for almost everywhere, including India. But look closer at what that rent agreement really is: a legally binding promise to pay a fixed amount for nine years, in exchange for the right to use that space. That looks a great deal like a loan. Yet under the old rules this multi-year financial commitment stayed invisible on the balance sheet — an investor reading the accounts had no direct way of knowing the company had locked itself into nine years of guaranteed payments.
Lease accounting is simply the rulebook that decides whether, and how, that hidden commitment shows up in the financial statements. Two new terms and one classification get introduced along the way — this article explains each one in plain language before putting them to work, with real numbers, so nothing is left as jargon.
Words you'll need first
This is not the store, the plane, or the office itself — that still belongs to the landlord. It is the company's own record of the value of its PERMISSION to use that thing for the length of the lease. Think of a pre-paid 10-trip bus pass: you don't own the bus, but the pass itself is worth something the day you buy it, and it 'wears down' a little with every trip you use. The ROU asset works the same way — it starts out worth roughly the same as the total future rent (see the Lease Liability, below), and every year a slice of that value is written off as depreciation, until it hits zero when the lease ends.
This is the flip side of the same coin — a running tally of the rent still owed for the rest of the lease. But the future rent isn't simply added up as-is: ₹1 lakh owed five years from now is worth less than ₹1 lakh owed today, because money in hand today could otherwise earn interest between now and then. So every future rent payment is 'discounted' — shrunk down using an interest rate — to what it's worth in today's rupees, and all of those shrunk-down amounts are added up into one number. From there, the Lease Liability behaves exactly like a bank loan balance: every rent payment reduces it, and a bit of 'interest' adds back to it every year, until it also reaches zero when the lease ends.
Two kinds of leases you'll hear about
Finance lease (a disguised purchase)
Picture a factory that leases a generator for 8 years, when the generator itself is only expected to last about 9 years in total — and the lease even gives the factory the option to buy it for ₹1 at the end. By the time the lease ends, the factory will have used up almost the entire life of that generator. Economically, this isn't really 'renting' at all — it's much closer to buying the generator on an EMI, with the paperwork simply calling it a lease. Accountants call this a finance lease (sometimes 'capital lease'): the tenant has taken on almost all the risk and reward of ownership, whatever the contract is titled.
Operating lease (genuine renting)
Now picture a retailer renting a shop inside a shopping mall for 5 years. That mall building will likely still be standing — and being leased to dozens of other shops — for another 40 or 50 years after this one lease ends. The retailer is only borrowing a small slice of the building's life, while the landlord keeps the real risk and reward: an empty shop is the landlord's problem, and the building's resale value is the landlord's upside. This is an operating lease — genuinely closer to 'renting' than to a disguised purchase. Most store rentals, office leases, and aircraft leases fall into this bucket.
Before vs. now
How it used to happen
Under the old Indian standard, Ind AS 17 (mirrored globally by the older IAS 17), a lease fell into one of the two buckets described above. Finance leases were capitalised, with an asset and a matching loan-like liability appearing on the balance sheet, much as they do today. But the vast majority of leases — store rentals, office space, aircraft — were classified as operating leases, and for these the company did nothing more than expense the rent as a single line in the P&L, usually spread evenly (straight-line) over the lease term. The multi-year commitment to keep paying that rent never touched the balance sheet at all; an analyst had to hunt for it in a footnote table of 'future minimum lease payments' and estimate its impact by hand.
How it's done now
Ind AS 116, effective for Indian listed companies from FY2019-20, erased that two-bucket system for the tenant. With a few narrow exceptions — leases of twelve months or less, and leases of genuinely low-value assets like a laptop or a water cooler — every lease, whether it's called 'operating' or 'finance', now has to be capitalised the same way: a Right-of-Use asset and a Lease Liability go on the balance sheet on day one, and the old single rent line in the P&L is replaced by depreciation of that asset plus interest on that liability.
Why EBITDA quietly went up
To see why this rule change quietly flattered EBITDA margins across corporate India, it helps to picture a P&L as a stack of lines, top to bottom: Revenue, minus Operating Expenses, equals EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation); minus Depreciation & Amortisation equals EBIT (operating profit); minus Interest equals Profit Before Tax. Every rupee of cost sits somewhere in that stack — and WHICH line it sits on changes what EBITDA looks like, even when the rupee amount is identical.
Under the old rules, rent was an Operating Expense, sitting ABOVE the EBITDA line, right alongside salaries, electricity, and raw materials. So every rupee of rent directly reduced EBITDA, exactly the way you'd expect it to.
Under Ind AS 116, that same cash outflow is split into Depreciation of the ROU asset (which sits BELOW the EBITDA line, between EBITDA and EBIT) and Interest on the lease liability (further below still, between EBIT and Profit Before Tax). Neither of these two new lines counts as an 'Operating Expense' any more — so neither of them reduces EBITDA at all.
Nothing about the underlying business changed. The company is paying the exact same rent to the exact same landlord. All that happened is that the expense moved to a part of the P&L that the EBITDA calculation simply doesn't look at — which is exactly why EBITDA and EBITDA margins for lease-heavy companies mechanically jumped the year this rule kicked in, and why comparing a company's 'FY19 EBITDA margin' to its 'FY20 EBITDA margin' can be misleading unless this shift is accounted for.
A worked example, with numbers
| Year | Old way — rent (P&L) | New way — depreciation | New way — interest | New way — total P&L charge |
|---|---|---|---|---|
| Year 1 | ₹1.00 cr | ₹0.76 cr | ₹0.38 cr | ₹1.14 cr |
| Year 2 | ₹1.00 cr | ₹0.76 cr | ₹0.32 cr | ₹1.08 cr |
| Year 3 | ₹1.00 cr | ₹0.76 cr | ₹0.25 cr | ₹1.01 cr |
| Year 4 | ₹1.00 cr | ₹0.76 cr | ₹0.17 cr | ₹0.93 cr |
| Year 5 | ₹1.00 cr | ₹0.76 cr | ₹0.09 cr | ₹0.85 cr |
| 5-year total | ₹5.00 cr | ₹3.79 cr | ₹1.21 cr | ₹5.00 cr |
On day one, the balance sheet also picks up a Right-of-Use asset of about ₹3.79 crore and an equal Lease Liability of about ₹3.79 crore. Figures are rounded to 2 decimals, so rows may not add up to the exact rupee.
- Day one: the balance sheet gains a Right-of-Use asset of about ₹3.79 crore and an equal Lease Liability of about ₹3.79 crore — the present value of five years of ₹1 crore rent, discounted at 10%.
- Years 1–3: the new total P&L charge (₹1.14 cr, ₹1.08 cr, ₹1.01 cr) is HIGHER than the old flat rent of ₹1 crore, because interest is front-loaded, just like on any loan in its early years.
- Years 4–5: the new total P&L charge (₹0.93 cr, ₹0.85 cr) is LOWER than the old flat rent of ₹1 crore, because most of the lease liability — and so most of the interest on it — has already been paid down.
- Added up over all 5 years, the total charge is the same either way, about ₹5 crore — the rule doesn't change how much the lease costs, only when the cost shows up and which P&L lines it sits on.
- And in every single one of those 5 years, EBITDA is now ₹1 crore higher than it would have been under the old rules, because none of the new depreciation-plus-interest charge sits above the EBITDA line — whereas the old rent expense used to sit there in full.
What it does to the financial statements
Impact on the P&L
- The single 'rent' line disappears from operating expenses, replaced by two new lines: depreciation of the ROU asset and interest on the lease liability.
- Both new lines sit below the EBITDA line, so reported EBITDA and EBITDA margin go up mechanically, with zero change to the actual business.
- The new total charge is front-loaded: usually higher than the old rent in the early years of a lease, and lower than it in the later years, because interest — like on any loan — shrinks as the liability gets paid down.
- Added up over the whole life of the lease, the total cost is unchanged. Only the timing, and which P&L lines carry it, change.
Impact on the Balance Sheet
- A new Right-of-Use asset appears under non-current assets, and a matching Lease Liability appears under liabilities, split into a current portion (due within a year) and a non-current portion (due later).
- Both total assets and total liabilities jump up by roughly the same amount on day one of a new lease.
- Because the lease liability counts as debt for ratio purposes, Debt/Equity and Net Debt/EBITDA typically look higher than before, even though the company hasn't taken on a single new rupee of bank borrowing.
- Fixed Asset Turnover and Return on Capital Employed shift too, since the asset base is now bigger.
- Both numbers shrink every year — the ROU asset through depreciation, the lease liability through repayments — so the effect fades out gradually over the life of each lease, unless a new lease is signed to replace it.
Which standard covers this
In India this is governed by Ind AS 116 – Leases, notified under the Companies (Indian Accounting Standards) Rules and applicable to companies that follow Ind AS — broadly, listed companies and large unlisted companies above the prescribed net worth thresholds. It replaced the older Ind AS 17.
How it's recognised globally
Globally, the equivalent is IFRS 16, issued by the International Accounting Standards Board and effective worldwide from January 2019 — Ind AS 116 is India's near-identical adoption of it, and between the two there is effectively no difference in outcome: 100% of qualifying leases (everything except the short-term and low-value exemptions) get the same Right-of-Use-asset-plus-Lease-Liability treatment, no matter what the contract calls itself.
The one major economy that did not fully converge is the United States. Under US GAAP's ASC 842, the operating-versus-finance-lease classification still matters for how the P&L looks, even though both kinds now appear on the balance sheet. A lease is generally treated as a finance lease if it meets tests such as ownership transferring at the end, a bargain purchase option, the lease term covering roughly 75% or more of the asset's remaining useful life, or the present value of the payments coming to roughly 90% or more of the asset's fair value — these percentages are commonly used working benchmarks rather than strict legal cut-offs, but they're still how most US companies decide in practice. Real estate and store leases almost always fail both the 75% and the 90% tests, since a building usually has decades of useful life left, so in practice the large majority of US corporate real-estate and retail-store leases stay classified as 'operating' and keep a single, old-style straight-line rent expense in the P&L. Equipment and aircraft leases, which tend to use up much more of an asset's total life, are far more likely to cross those thresholds and land in the finance-lease bucket, getting the split depreciation-and-interest treatment instead. So two airlines — one Indian, one American — leasing near-identical aircraft could end up showing the exact same cost completely differently in their P&L, purely because of which country's rules apply.
Real example — Indian listed company
Airlines almost never buy their aircraft outright — a single wide-body plane can cost several hundred crore rupees — so most airlines lease their fleet instead, the same way a small business owner might lease a car rather than buy one outright. IndiGo, India's largest airline, leases the large majority of its aircraft this way rather than owning them.
Before Ind AS 116 came into effect, almost none of this showed up on IndiGo's balance sheet. IndiGo could be sitting on binding commitments to pay lease rent on 200-plus aircraft for years into the future, and technically, its balance sheet wouldn't show a single rupee of that as a liability — it was all tucked away in a footnote.
After Ind AS 116, all of it had to come onto the balance sheet as Right-of-Use assets and Lease Liabilities. Based on IndiGo's own results for the year ended 31 March 2024, its capitalised lease liability was reported at roughly ₹43,500 crore, with total debt including this lease liability at roughly ₹51,300 crore. To put ₹43,500 crore in context: that single number, which exists purely because of an accounting rule about aircraft rental agreements, is larger than the entire market value of many well-known listed Indian companies — and none of it was recorded as a liability before this rule changed.
Practically, this means two things for anyone reading IndiGo's results. First, a large part of what looks like 'debt' and 'assets' on its balance sheet isn't money borrowed from a bank at all — it's the accounting shadow of aircraft rental agreements. Second, IndiGo's EBITDA margin, often highlighted as a sign of operational strength, is partly flattered by the fact that aircraft rent no longer sits above the EBITDA line the way it used to before FY2019-20. Neither point is a criticism of IndiGo specifically — every airline and every lease-heavy company reports this way now. It's simply worth knowing before comparing IndiGo's numbers to a pre-2019 year, or to a US airline that classifies more of its aircraft leases as 'finance leases' under a different rulebook.
Where you'll see this
Related concepts
Lessor Accounting
Why Ind AS 116, the same standard that erased the operating-lease-vs-finance-lease distinction for TENANTS, deliberately left that exact distinction fully intact for LANDLORDS.
Sale and Leaseback
Why a company selling its own head office building to raise cash — and then immediately renting it back to keep using it — doesn't always get to book the full sale profit it might expect.