Thematic | April 2019

Ind-AS
Lease accounting undergoes revision
Operating leases to be capitalized, facilitate better comparability

 Ind-AS 116 accounting for leases comes into effect from FY20 (replacing the erstwhile
Ind 17). The new standard requires long-term liability toward operating lease payment
(currently off balance sheet) to be recognised in the balance sheet with a
corresponding intangible asset in the form of right-to-use the asset.
 The new standard will bring a paradigm change in the reported earnings
(PAT/EBIDTA), return ratios (RoCE/RoE), leverage, asset turns and valuation multiples,
thereby improving the comparability in financials of players with different asset
ownership/lease strategy within the same sector.
 The companies with forex-denominated lease will have more volatility in earnings, as
the MTM due to foreign exchange fluctuation arising from lease liabilities so
recognised needs to be routed through the income statement.
 This is an accounting change, and thus, will not bring any change in overall cash flows
for companies. However, reported operating cash flows will increase with a
corresponding decline in financing and investing cash flows.
 Our analysis of BSE-500 companies highlights that 20 companies have rentals in excess
of 5% of revenues and will be most impacted. These companies operate primarily in
the airline, retail, quick service restaurants, telecom and entertainment sectors, which
are highly reliant on the operating lease model.
 Out of these 20 companies, 7 have predominantly cancellable leases, where
managements have the discretion to follow the revised standard or to continue with
the existing accounting practice.
 Even for the remaining 13 companies, it is difficult to estimate the actual impact, given
the absence of adequate information on critical inputs (such as outstanding lease
tenure, cost of debt, choice of transition provision used and qualifying transactions to
be governed under the lease). We have thus assumed an 11% discounting rate,
estimated average lease tenure (based on the FY18 disclosures) and prospective
approach of transition to estimate the impact on those 13 companies (amongst 20),
where the details of committed future lease rentals are disclosed. Our analysis
concludes that:

EBITDA will rise for all companies

 The new accounting standard will require companies to (a) de-recognize the
expense of operating lease rentals (above EBITDA), (b) recognize additional
finance cost (on the lease obligation recognized) and (c) amortize intangible
asset (right-to-use) below EBITDA.
 This will lead to an increase in EBITDA for companies across the tenure of the
lease. For the shortlisted companies, it would imply that FY18 EBITDA would be
higher by ~ 68% if the standard was applicable w.e.f. FY18.

Earnings will be materially impacted…

 While the lease asset will be amortized on a straight line basis over the lease
tenure, the finance cost will be the highest during the initial period and trend
downward gradually over the tenure of the lease.
 Hence, cumulatively on the entire tenure of the lease, earnings will remain
unaltered – the first half of the lease tenure will witness a decline in earnings,
Sandeep Ashok Gupta – Research Analyst (S.Gupta@MotilalOswal.com); +91 22 6129 1551
Research Analyst: Mohit Baheti (Mohit.Baheti@MotilalOswal.com); 6129 1525/ Umesh Jain (Umesh.Jain@MotilalOswal.com); 7193 4221
April 2019 are advised to refer through important disclosures made at the last page of the Research Report.
Investors 1
Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.
 Thematic | Ind-AS116-Lease

while the latter half will see an increase in reported earnings. Also, MTM losses
on forex liability additionally recognized (on lease rentals capitalized) will likely
bring volatility in the income statement.
…however, direction may depend on choice of transition approach
 We note that the rules provide three different approaches for transitioning (the
existing lease arrangements) into the financials. These are (a) prospective
method, (b) modified retrospective method and (c) full retrospective method.
 We believe that adopting the prospective approach will mean an adverse impact
on earnings over the near term, while the retrospective and the modified
approach may lead to (generally) higher earnings over the near term with a
corresponding adverse hit on the net worth.
 Our discussions with experts suggest that most corporates may choose to adopt
the retrospective or the modified retrospective approach.
Leverage will rise significantly
 The new standard requires the lease liability on long-term operating leases to be
recognized as part of debt. This will imply a significant rise in the leverage ratio.
 We estimate that (if this was applicable from FY18) the D/E of the shortlisted
companies on an aggregate basis will increase from 0.7x to 1.5x (assuming
prospective approach), while debt/EBITDA for the said universe would increase
from 2.2x to 2.8x.
Multiples likely to undergo significant change
 We believe that this is an accounting change, and thus, should not bring any
change in overall valuations. However, with the change in the key financial
metrics (EPS, EBITDA, Book value), the multiples of companies are likely to
change materially.
Exhibit 1: Companies where rent expenses were 5% or more of revenues (FY18)
Company Sector Rent as % of revenue
SpiceJet Aviation 22
Interglobe Aviation Aviation 16
Jet Airways Aviation 15
Inox Leisure Media and Entertainment 20
PVR Media and Entertainment 18
Dish TV Media and Entertainment 6
Jubilant Food. QSR 11
Coffee Day Enterprises QSR 6
Bata India Retail 14
Trent Retail 13
Shoppers Stop Retail 10
Future Lifestyle Retail 10
Rel. Comm. Telecom 9
Bharti Infratel Telecom 5
Mahindra Holiday Hotels 10
Blue Dart Exp. Logistics 9
Indiabulls Integrated Comm. Trading & Distribution 9
Guj Fluorochem Industrial Gases 7
SCI Shipping 7
Firstsource Solutions IT 5

April 2019 2
 Thematic | Ind-AS116-Lease

Exhibit 2: List of companies/sectors are expected to be impacted materially (INR b)

FY18 Actual FY18 Revised
DE ratio Asset EBITDA DE ratio Asset EBITDA
Company Sector Debt EBITDA Debt EBITDA
(x) turn (x) Margin (%) (x) turn (x) margin (%)
Jet Airways Aviation 84 (1.2) 1.9 1 0 162 (2.3) 1.2 25 10
SpiceJet Aviation 13 (23.3) 1.9 7 10 58 (104.1) 0.9 15 19
Interglobe Aviation Aviation 25 0.3 1.1 30 13 102 1.4 0.8 55 24
Inox Leisure Media 3 0.4 1.0 2 15 16 2.3 0.5 4 28
PVR Media 8 0.8 1.0 4 17 18 1.7 0.7 6 28
Guj Fluorochem Industrial Gases 20 0.4 0.5 7 19 33 0.7 0.4 9 23
Blue Dart Exp. Logistics 4 0.8 2.9 4 13 9 1.7 1.9 4 15
Firstsource Soltion. IT 7 0.3 1.2 5 13 8 0.3 1.1 5 15
Coffee Day Enterprises QSR 50 2.1 0.4 6 18 52 2.2 0.4 7 20
Shoppers Stop Retail 1 0.1 2.3 2 4 2 0.3 2.2 2 6
Trent Retail 4 0.2 1.0 2 8 5 0.3 1.0 2 11
Future Lifestyle Retail 7 0.5 1.3 4 8 10 0.6 1.2 5 11
Bharti Infratel Telecom 0 0.0 0.3 31 47 19 0.1 0.3 34 52
227 0.7 1.0 105 12 495 1.5 0.8 176 19
Source: Company annual report, MOFSL; *Inox Leisure Limited is a subsidiary of Gujarat Flurochemicals Limited
Note: 1. Impact on FY18 financials has been calculated; 2. For assumptions refer page no. 11.

April 2019 3
 Thematic | Ind-AS116-Lease

Big changes as we migrate to new leasing norms

Balance sheet size to expand significantly

 The new accounting standard Ind-AS 116 ‘Leases’ is effective from the accounting
period commencing on or after 01st Apr’19, replacing the existing Ind-AS 17. The new
Ind-AS will bring significant change in Lease Accounting by replacing the dual
classification model (Operating v/s Finance lease) of erstwhile Ind-AS 17 to a single
measurement method.
 The new standard prescribes two exceptions for its applicability: (a) Low value
underlying assets and (b) short-term leases – lease term less than 12 months.
 For the companies having cancellable leases, the discretion to follow the revised
standard or continue with the existing accounting practice is dependent on
management’s judgment.
 The new Ind-AS will bring operating leases (along with finance lease) on the balance
sheet, in the form of a ‘right-to-use’ asset and a lease liability, thereby making balance
sheet ‘asset heavy’ and ‘indebted’.
 However, the accounting of leases from a Lessor’s point of view remains unchanged.

India Inc.’s journey of Ind-AS

 India Inc. adopted the IFRS-converged financials (Ind-AS) in a phased manner
over FY17-18. Ind-AS, based on ‘substance over form’ and ‘fair valuation’, has
materially impacted the operating metrics and return ratios of companies,
besides providing more disclosures.
 Further, to enhance financial reporting and disclosures, accounting regulators
are issuing new accounting guidance globally. Accordingly, the Indian accounting
regulator — The Institute of Chartered Accountants of India (ICAI) – has issued a
new standard on (a) Revenue Recognition (Ind-AS 108), applicable with effect
from FY19, and (b) Lease Accounting (Ind-AS 116), applicable with effect from
FY20.

New Ind-AS on ‘Leases’ to make balance sheets heavy and indebted

 The new accounting standard Ind-AS 116 ‘Leases’ is effective from the
accounting period commencing on or after 01st Apr’19, replacing the existing
Ind-AS 17. The new Ind-AS will bring significant change in Lease Accounting by
replacing the dual classification model (Operating v/s Finance lease) of erstwhile
Ind-AS 17 to a single measurement model.
 The erstwhile standard allowed companies to keep operating leases as off
Operating leases will be balance sheet items and a single charge in income statement as rent. The new
capitalized on balance
Ind-AS will bring operating leases (along with finance lease) on the balance
sheet, making it “asset
heavy” and “indebted”
sheet, in the form of a ‘right-to-use’ asset and a lease liability, thereby making
balance sheet ‘asset heavy’ and ‘indebted’.
 Changes will come in the income statement, such as (a) increase in EBITDA (as
there will be no rental charges), (b) increase in depreciation and amortization
(on the asset recognized), and (c) increase the in finance cost (on the present
value (PV) of liability recognized).
 The new standard prescribes two exceptions: (a) Low value underlying assets,
and (b) Short term leases – lease term less than 12 months.
 However, the accounting of leases from a Lessor’s point of view remains
unchanged.

April 2019 4
 Thematic | Ind-AS116-Lease

Cancellable v/s Non-cancellable – a management discretion

Classification of operating
lease would depend on
management’s prudent
judgement
 The existing Ind-AS 17 does not differentiate accounting treatment for
cancellable and non-cancellable lease arrangements. Both these lease
arrangements were charged to the income statements as the annual operating
lease expense. But, the new Ind-AS 116 has prescribed certain conditions based
on the classification of lease.
 Classification of lease, which depends on management’s prudent judgement and
terms of lease arrangement, is very important as it is a trigger factor for the
capitalization of lease on the balance sheet. Our discussions with various
experts assert that cancellable leases would continue to exist as is and rental
would be charged to the income statement.
 Each lease agreement shall be assessed based upon these two parameters (both
should be satisfied) to qualify for non-cancellable lease, these are (a) lessee has
an option to extend the lease and is reasonably certain to exercise that option,
and (b) lessee has an option to terminate the lease and is reasonably certain not
to exercise that option.
 For instance, BATA India’s rental expense charged to income statement in FY18
amounts to INR3,622m with majority of the leases being cancellable. Total
qualifying lease expense (for non-cancellable lease) is a mere INR66m.
Companies such as BATA India whose qualifying rent expense is low even
though rent expense is higher, may not be impacted materially.

Exhibit 3: Impact analysis of new lease accounting standard Ind AS 116 from lessee perspective
Particulars Existing Ind AS 17 New Ind AS 116 Impact
 Capitalisation of asset with a
 Dual measurement method for  Single measurement method will be
corresponding increase lease
recognition of lease is allowed in allowed for all leases except (a)
Lease recognition liability
(a) Operating lease, and (b) Short-term leases (Less than 12
 Increases comparability of
Finance lease. months), and (b) Low-value asset
financial statements
FINANCE LEASE
 Right-to-use asset is created on the  Right-to-use asset will be created on
asset side of the balance sheet the asset side of balance sheet  No impact; financial
Finance lease
 Correspondence, a liability for  Correspondence, a liability for future treatment remains the same
future lease payment is created lease payment will be created
OPERATING Lease
 Depreciation on capital asset on SLM
 Balance sheet will become
 Lease rental expense is charged to basis
Operating lease asset heavy, and heavily
profit and loss account  Interest Charge on PV of lease
geared
liability
 No liability recognized for future  Present value of lease payment to be  Higher operating lease term
Effect of operating
committed operating lease made over the lease term will be will increase debt level of
lease term
payment. recognized as liability. enterprises

 Continuous re-measurement
Operating lease rental
 No lease liability recognized.  Lease liability will be re-measured at of lease liability will bring
payable in foreign
Hence, balance sheet is indifferent. each reporting date. volatility in balance sheet and
exchange
Income statement.

Source: MOFSL

April 2019 5
 Thematic | Ind-AS116-Lease

Material implication on financial metrics

Reported Earnings, leverage, Return ratios to undergo a change

 With the recognition of liabilities of committed future lease rentals and corresponding
right to use the asset, the leverage in the balance sheet will increase.
 The new accounting standard will require companies to (a) derecognize the expense of
operating lease rentals (above EBITDA), (b) recognize additional finance cost (on the
lease obligation recognized), and (c) to amortize intangible asset (right-to-use) below
EBITDA. This will lead to an increase in EBITDA for companies across the tenure of the
lease.
 While the lease asset will be amortized on a straight line basis over the lease tenure,
the finance cost will be the highest during the initial period and trend downwards
gradually over the tenure of the lease. Hence, cumulatively on the entire tenure of the
lease, earnings will remain unaltered; the early half of the lease tenure will witness a
decline in earnings while the latter half will see an increase in reported earnings.
 Thus, the new standard will bring a paradigm change in the reported earnings (PAT/
EBIDTA), Return ratios (RoCE/ ROE), leverage, asset turns and the valuation multiples.

Capitalisation of asset to bloat the balance-sheet

 Ind-AS 116 requires companies to capitalize leases (except low-value lease and
short-term leases) on the balance sheet. Companies will have to record (a)
Right-to-use assets – Intangible lease asset, and (b) a corresponding present
value (PV) of lease liability – discounting future lease obligation to PV. This will
result in the balance sheet getting asset heavy and highly geared.
 Carrying value of lease asset would reduce more quickly than carrying amount
Present value of gross lease
liability would be of lease liability as (a) lease asset will depreciate based on the straight line basis,
recognized as ‘lease while, (b) lease liability will reduce by the amount of annual lease rental paid,
liability’… but simultaneously, will increase due to the annual interest accrued on the PV of
lease liability.
 Therefore, initial recognition of lease asset and lease liability would be recorded
at same amount. As lease progresses towards maturity, amount of lease assets
would be lower than lease liability.
 This new standard would ultimately boil down to the material impact on various
…with a corresponding
key ratios, with companies seeing (a) an increase in Debt-Equity, (b) an increase
‘Right to use asset’
in working capital (rise in current portion of lease liability), (c) a decrease in
current ratio, (d) earnings (EBITDA/ PAT) and most importantly (d) change in
return ratios – RoE and RoCE.
 The impact of these ratios will depend on various factors, primarily the
transitional provision adopted by the companies. Different transitional
provisions would lead to different level of impact on the net-worth and income-
statement. It is imperative to note that Ind AS 116 provided three methods (a)
Prospective method, (b) Modified retrospective method and (c) Full
retrospective method. These methods are discussed in detail later in this note.

April 2019 6
 Thematic | Ind-AS116-Lease

Earnings to get materially impacted

 In the previous Ind-AS 17, annual lease expense was recognized in the income
statement as ‘Rent’. On the contrary, the new lease accounting standard of Ind-
AS 116 would de-recognize annual lease expenses and will recognize
depreciation (on intangible right-to-use asset recognized) and interest expense
(on PV of lease liability).
 In both — the new as well as the old accounting standard – expense over the
De-recognition of lease
expense would increase term of the lease would typically remain the same. However, the pattern and
EBITDA... timing of expense recognition would vary. In the old standard, annual lease
expense is charged to income statement based on the straight line basis
(systematic allocation of lease expense). In the new standard, while
depreciation would be charged on a straight line basis, interest expense would
be recorded on the remaining lease liability at year-end.
…while PAT impact would  Thus, the expense recognition under the new standard would impact the
depend on lease term income statement adversely in the initial period of the lease term due to front
phase and transition loading of interest expense. As the lease term would approach towards the end,
method interest expense would typically reduce, and impact on income statement
would be positive.
 The new treatment would thereby lead to increased EBITDA; while the actual
impact on PAT would depend on the phase of the lease portfolio, the transition
approach adopted, amongst others.

Forex volatility will increase in P&L

 Among the several indirect aspects pertaining to the implication of the new
Foreign currency
denominated leases would standard, we believe the forex impact on operating leases denominated in
bring volatility in income foreign currency would materially impact the income statement. This will
statement primarily be on account of MTM (due to forex fluctuation) arising from lease
liabilities so recognized; which needs to be charged through the income
statement.
 For example, in a company like INDIGO, majority of the operating leases of an
aircraft is denominated in foreign currency and the fair valuation of the lease
liability at every reporting date would bring in high volatility in the income
statement. Though the impact can be managed through derivative hedges, we
will have to wait and see how companies manage the forex volatility risk.

Transition approach to be a game changer!

 Ind AS 116 provides three different accounting approaches at the time of
Transitional method would
transition, these are the (1) Prospective approach — no impact in opening net
determine the extent of
impact worth, (2) Retrospective approach - impact of existing lease adjusted in opening
the net worth. The Retrospective approach is further classified based on the
discounting factor used, such as (a) Full Retrospective approach, and (b)
Modified Retrospective approach.
 Our discussion with experts suggest that majority of the companies would
follow the Modified Retrospective approach for transition. We have analyzed
differential impact from each accounting approach below:

April 2019 7

Prospective approach will
lead to higher expenses in
income statement during
initial period of lease term
Excess of depreciation and
finance cost vs cumulative
lease expense shall be
charged to equity directly.
April 2019
Thematic | Ind-AS116-Lease
Approach I - Prospective
Under this approach, the lease liability shall be measured at the present value (PV)
of the remaining lease payments. Right-to-use asset shall be measured at the PV of
the lease liability (Adjusted by the amount of any prepaid or accrued lease
payments). This accounting approach can have the following impacts:
 Initially, right-to-use asset and lease liability shall be recognized at the same
value.
 Retrospective effect shall not be given in the balance sheet. Therefore,
equity shall remain unchanged.
 De-recognition of operating lease charges and recognition of depreciation
and finance cost would positively impact EBITDA.
 However, lease expenses will be front loaded in the new accounting standard
due to (a) amortization of right-to-use asset, (b) unwinding of interest
component (finance cost) on the lease liability, which results in higher costs
being recognized during the beginning of the lease term. This would reduce
profit, and thereby net margins, with RoE being impacted. (refer Annexure II for
details)
Approach II - Modified retrospective
 Right-to-use asset has to be recognized at a carrying amount as if the new
standard has been applied from the date of initial commencement of the lease
agreement. Thereafter, it has to depreciate cumulatively over the pre-
transitional period using the depreciation method; the depreciated amount shall
be carried in the balance sheet.
 The lease liability shall be carried at the present value of lease liability for the
remaining lease term (Same treatment as in prospective method), discounted
using the incremental borrowing rate on initial application of new lease
accounting standard. (Refer annexure III for details).
 This accounting approach can have the following impacts:
 Discounting of right-to-use asset from initial original lease application shall
decrease its value. Therefore, depreciation expense would be lower.
 Lower depreciation expenses compared with prospective method shall have
positive impact on profit & loss account.
 While, comparing with prospective method, finance cost shall continue to
be same.
 Depreciation and finance cost shall be calculated as if the lease is capitalized
from the date of origination of the lease term. Any excess depreciation and
finance cost till date compared with cumulative annual lease expenses till
date shall be charged to equity directly. Therefore, effect of front loading of
interest expenses shall go directly to the balance sheet, reducing equity.
 We note that a one-time effect on equity shall be substantial; this will
reduce net worth from the balance sheet. Lower net worth base will boost
return ratios.
8
 Thematic | Ind-AS116-Lease

Approach III - Full retrospective

 Right-to-use asset has to be recognized at a carrying amount as if the new
standard has been applied from the date of initial commencement of the lease
agreement. Thereafter, it has to depreciate cumulatively over the pre-
transitional period, using the depreciation method with the depreciated amount
being carried in the balance sheet.
 The lease liability would be carried at PV of the lease liability for the remaining
lease term, discounted using an incremental borrowing rate on the date of
origination of the lease term. (Refer Annexure IV for details).
 This accounting approach can have the following impacts:
 Depreciation and finance cost shall be calculated as if the lease is capitalized
from the date of origination of the lease term. Any excess depreciation and
finance cost till date compared with cumulative annual lease expenses till
date shall be charged to equity directly. Therefore, effect of front loading of
interest expenses shall go directly to the balance sheet, reducing equity.
 The only difference between Full Retrospective and Modified Retrospective
approach is that the full retrospective approach requires discounting of
right-to-use asset and lease liability using an incremental borrowing rate at
the time of origination of the lease term. Whereas, the modified
retrospective approach provides flexibility to use incremental borrowing
rate at the time of initial application of the new lease accounting standard.

Operating cash flows to rise ; while investing /financing cash flows declines
 The change in accounting standard will not impact the amount of cash
transferred from the lessee to the lessor. Hence, total cash outflow of lessee
would remain the same.
Overall cash flows will  The presentation of cash outflow is expected to change. Operating cash flow is
remain unchanged. expected to increase due to de-recognition of the annual lease expense; the
financial cash flow is expected to reduce due to payment of the principal
component on lease liability and the interest thereon.

Multiples likely to witness a material change

 While, the change in accounting is unlikely to being a fundamental change in the
Multiples likely to evident valuation of the company. The change in the various critical parameters such as
significant changes
EBITDA, PAT, Debt, book value is likely to impact the multiples materially.

April 2019 9
 Thematic | Ind-AS116-Lease

Exhibit 4: Significant impact expected on financial metrics

Expected
Metrics Expected change Measures Reason
impact
Balance sheet
Debt equity Long-term  Lease liability is expected to increase debt, while equity is
Increase Negative
(Leverage) solvency expected to decrease
 Current portion of lease liability would increase financial liability.
Current ratio Decrease Negative Liquidity
While, entire lease asset would be recognized as non-current.
Income Statement
Operating  De-recognition of annual lease expense is expected to increase
EBITDA margin Increase Positive
efficiency EBITDA, while revenue will remain unchanged.
 (a) First half of the lease term would have lower net profit due to
front loading of lease expense (Higher interest charges). Hence,
Profit net profit margin would be lower.
Net profit margin Depends Depends
efficiency (b) Later half of the lease term would have higher net profit since
interest expense will reduce over the life of the lease term.
Hence, net profit margin would be higher.
Other
Asset  Capitalization of annual rental expense would increase assets,
Asset Turnover Decrease Negative
efficiency while revenue will remain the same.
 (a) Front loading of interest expense would reduce earnings in
Decrease in initial the initial phase of the lease term, leading to lower RoE.
Equity holder
RoE period, Increase Depends (b) In the latter half of lease term, earnings are expected to
return
in later half increase due to decrease in interest expense, resulting in higher
RoE.
 (a) Lower profit in initial period of lease term would increase P/E
Increase in initial
Valuation ratio.
PE ratio period, Decrease Depends
measure (b) Higher profit in the latter half of lease term would decrease
in later half
P/E ratio
Valuation  Change in presentation of annual lease expense would de-
EV/ EBITDA multiple Decrease Positive
measure recognize operating lease expense from income statement.
Source: MOFSL

April 2019 10
 Thematic | Ind-AS116-Lease

High leasing model sectors – materially impacted

Aviation, Entertainment, Retail, Telecom, QSR in focus

 Companies operating with high operating lease model will be impacted significantly
under the new accounting standard — Ind-AS 116. Impact on these companies,
though, would depend on portfolio of leases – Cancellable v/s Non-cancellable lease,
Variable rental leases, among others.
 Our assessment of BSE500 companies has enabled us to identify 20 companies with
material impact. We have selected companies where the rent expenses accounted for
5% or more on the revenue. These companies are primarily engaged in Aviation,
Media & Entertainment, QSR, Retail and Telecom.
 We went through the annual report of these 20 companies to understand and assess
material non-cancellable leases (qualifying lease rent). We found 13 companies
(Portfolio Company) from this list, which have material non-cancellable leases and we
believe its impact could be significantly higher.
 Assessing the impact on various metrics is difficult given the unavailability of lease
details like lease term, type of lease, discounting factor, amongst others. We have
made followings assumptions:
 We have considered the prospective approach to determine impact on FY18
reported financial performance.
 Qualifying operating lease due within one year as reported in FY17 AR has been
considered as lease expenses for FY18.
 Average lease term of outstanding leases as on FY18 is computed by dividing total
future lease liability by one year’s lease expense.
 We have assumed incremental borrowing rate at 11% for discounting total future
minimum lease liability.
 For the shortlisted (13) companies the aggregate (a) debt equity increases sharply
from 0.7x to 1.5x, (b) Asset turns declines from 1.0x to 0.8x, and EBITDA rises 68%.

Leverage will rise significantly; D/E is expected to spike

 The new standard requires the lease liability on long-term operating leases to be
recognized as part of the debt. This will imply a significant increase in the debt
as well as leverage ratio.
 We have capitalized qualifying lease rentals based on assumptions listed earlier
to calculate increase in debt. As a result, total debt of our portfolio companies
has increased from INR227b (FY18 Annual report) to a revised debt of INR495b.
This led to sharp increase in total debt equity ratio from 0.7x to 1.5x.
Recognition future lease  Our assessment suggests that the Aviation industry is most impacted as airline
liability on the balance companies finance aircraft through off-balance sheet operating leases. Along
sheet shall increase with aircraft, airport facilities such as boarding gates, check-in kiosks are also
leverage, leading to higher
generally rented from respective airport owners.
D/E ratio
 The Aviation industry is followed by Media & Entertainment, Retail and
Telecom, where companies enter into large rental agreements for retail outlets
and mobile tower sharing agreements.

April 2019 11
 Thematic | Ind-AS116-Lease

Exhibit 5: Debt expected to double; DE ratio to spike (INR b)

Company Name Sector Debt DE ratio (x) Revised Debt Revised DE ratio (x)
Jet Airways Aviation 84 NM* 162 NM*
SpiceJet Aviation 13 NM* 58 NM*
Interglobe Aviation Aviation 25 0.3 102 1.4
Inox Leisure Media and Entertainment 3 0.4 16 2.3
PVR Media and Entertainment 8 0.8 18 1.7
Guj Fluorochem Industrial Gases 20 0.4 33 0.7
Blue Dart Exp. Logistics 4 0.8 9 1.7
Firstsour.Solu. IT 7 0.3 8 0.3
Coffee Day Enter QSR 50 2.1 52 2.2
Shoppers St. Retail 1 0.1 2 0.3
Trent Retail 4 0.2 5 0.3
Future Lifestyle Retail 7 0.5 10 0.6
Bharti Infra. Telecom 0 0.0 19 0.1
227 0.7 495 1.5
Note: Impact on FY18 financials using assumptions as mentioned above Source: Company, MOFSL
* Negative net worth

Asset turnover to shrink

Recognition of right to use
asset shall increase asset
base, leading to low asset
turnover ratio
 Recognition of right-to-use asset for operating leases will increase the overall
asset base of companies, while revenue will remain unaltered.
 Increase in asset base would depend on the term of lease, borrowing rate used
for discounting and qualifying rental expense for lease capitalization.
 Total asset base of portfolio companies has increased from INR899b to
INR1,167b. Higher asset base has decreased the overall asset turnover from 1.0x
to 0.8x. This may impact RoE adversely.

Exhibit 6: Asset turnover declines from 1.0x to 0.8x (INR b)

Asset turnover Revised Asset
Company name Sector Revenue Asset Revised asset
ratio (x) turnover ratio (x)
Jet Airways Aviation 245 130 2 208 1.2
SpiceJet Aviation 78 41 2 86 0.9
Interglobe Aviation Aviation 230 208 1.1 286 0.8
Inox Leisure Media and Entertainment 13 13 1.0 26 0.5
PVR Media and Entertainment 23 23 1.0 34 0.7
Guj Fluorochem Industrial Gases 39 81 0.5 94 0.4
Blue Dart Express Logistics 28 10 2.9 15 1.9
Firstsour.Solution IT 35 30 1.2 32 1.1
Coffee Day Enterprises QSR 34 89 0.4 91 0.4
Shoppers St. Retail 41 18 2.3 19 2.2
Trent Retail 23 23 1.0 24 1.0
Future Lifestyle Retail 49 38 1.3 41 1.2
Bharti Infratel Telecom 66 194 0 213 0.3
906 899 1.0 1167 0.8
Note: Impact on FY18 financials using assumptions as mentioned above Source: Company, MOFSL

April 2019 12
 Thematic | Ind-AS116-Lease

EBITDA to rise for all companies

De-recognition of operating
lease expense will lead to
increase in EBITDA
 De-recognition of operating lease rentals (above EBITDA) will lead to increase in
EBITDA. Our impact assessment on portfolio companies suggest that total
EBITDA has increase from INR105b to INR176b. This would lead to significant
aggregate margin expansion from 11.5% to 19.4%.
 Our analysis suggests that EBITDA of airline companies is expected to increase
significantly followed by the Media & Entertainment industry.

Exhibit 7: EBITDA to boost companies with larger lease asset portfolio (INR b)
EBITDA Revised Revised EBITDA Increase in
Company Name Sector EBITDA
Margin(%) EBITDA Margin (%) EBITDA (%)
Jet Airways Aviation 1 0.3 25 10.3 3110
SpiceJet Aviation 7 9.6 15 19.1 100
Interglobe Aviation Aviation 30 12.8 55 24.0 87
Inox Leisure Media and Entertainment 2 14.7 4 28.1 91
PVR Media and Entertainment 4 17.2 6 27.6 61
Guj Fluorochem Industrial Gases 7 18.6 9 23.3 25
Blue Dart Exp. Logistics 4 12.5 4 15.4 23
Firstsour.Solution IT 5 13.3 5 15.2 14
Coffee Day Enterprises QSR 6 18.4 7 20.2 10
Shoppers Stop Retail 2 4.3 2 5.6 28
Trent Retail 2 8.2 2 10.5 29
Future Lifestyle Retail 4 8.3 5 10.7 29
Bharti Infratel Telecom 31 47.3 34 52.1 10
105 11.5 176 19.4 68
Note: Impact on FY18 financials using assumptions as mentioned above Source: Company, MOFSL

April 2019 13
 Thematic | Ind-AS116-Lease

Annexure I
Illustration - to understand the impact on financial statements of the new standard:
 Existing Ind AS17 leases requires charging annual lease expense in the balance
sheet as an operating expense. While, under the new Ind AS116, annual lease
expenses shall be de-recognized due to capitalization of lease expenses.
 We have considered INR1.0m as rental expenses p.a., lease term of 10 years,
and a discounting rate of 11%.
 Capitalization of lease liability and asset has been recognized at INR7.19m at PV,
discounted using interest rate implicit in the lease.
 Asset has been depreciated using a straight line basis. Depreciation charged to
income statement is INR0.7m.
 While, lease liability is adjusted as follows (a) increased by interest expense of
INR0.7m, and (b) reduced by annual lease payment of INR1.0m.
 Therefore, higher interest cost in the initial years of lease has dragged
profitability. This is expected to turn the other way round i.e. finance cost would
reduce as the lease term approaches maturity. This would impact income
statement positively in the latter half of the lease term.

Exhibit 8: Impact analysis from new lease accounting standard (INR)

Particulars Ind AS17 Ind AS116 Impact
Profit/(Loss)
Lease rental expense (10,00,000) 0 10,00,000
EBITDA (10,00,000) 0 10,00,000
Dep./amortization charges 0 (7,19,087) (7,19,087)
EBIT (10,00,000) (7,19,087) (2,80,913)
Finance Cost 0 (7,90,996) (7,90,996)
Profit/(Loss) before tax (10,00,000) (15,10,083) (5,10,083)
Balance Sheet
At beginning
Right to use asset 71,90,870
Lease liability 71,90,870
Closing
Right to use asset 64,71,783
Lease liability 69,81,865
Assumptions:
Lease term (years) 10
Rental P.A. 10,00,000
Discount rate 11%
Source: MOFSL

April 2019 14
 Thematic | Ind-AS116-Lease

Annexure II – Prospective approach

Assumptions:
 Original lease term: 15 years, Remaining lease term: 3 years
 Date of application of new lease accounting standard: 1st Apr’19
 Incremental borrowing rate at the time of the initial application of the new lease
accounting standard: 11% P.A.

Exhibit 9: No transitional effect on equity -reserve and surplus (INR)

Particulars 31-Mar-20 01-Apr-19 Existing Ind AS
Assets
Right of use asset 16,29,142 24,43,715 -
Total Asset 16,29,142 24,43,715 -
Equity
Other equity (83,381) 0 -
Total equity (83,381) 0 -
Liability
Lease liability 17,12,523 24,43,715 -
Total liability 17,12,523 24,43,715 -
Source: MOFSL

Exhibit 10: Front loading of dep. and interest expense will adversely impact P&L (INR)
Particulars 31-Mar-20 31-Mar-19
Depreciation expense (8,14,572)
Finance Cost (2,68,809)
Operating Lease 10,00,000 (10,00,000)
Impact on Profit/(Loss) for the year (83,380) (10,00,000)
Source: MOFSL

Exhibit 11: Increase in dep. and finance cost charge to P&L under new lease accounting standard (INR)
Cumulative
Lease PV of lease Fin. P&L charge P&L charge
Year DF lease liability Dep.
payment liability cost in Ind AS116 in Ind AS17
at YE
01-04-19 24,43,715
31-03-20 10,00,000 1.11 9,00,901 17,12,523 2,68,809 8,14,572 10,83,380 10,00,000
31-03-21 10,00,000 1.23 8,11,622 9,00,901 1,88,378 8,14,572 10,02,949 10,00,000
31-03-22 10,00,000 1.37 7,31,191 - 99,099 8,14,572 9,13,671 10,00,000
Source: MOFSL

April 2019 15
 Thematic | Ind-AS116-Lease

Annexure III – Modified Retrospective approach

Assumptions:
 Original lease term: 15 years, Remaining lease term: 3 years
 Date of application of new lease accounting standard: 1st April, 2019
 Incremental borrowing rate at the time of initial application of standard: 11%
P.A.

Exhibit 12: Excess dep. and fin. cost vs annual lease exp. till date charged to equity (INR)
Particulars 31-Mar-20 01-Apr-19 31-Mar-19
Assets
Right of use asset 9,58,783 14,38,174 -
Total Asset 9,58,783 14,38,174 -

Equity
Other equity (7,53,741) (10,05,541) -
Total equity (7,53,741) (10,05,541) -

Liability
Lease liability 17,12,523 24,43,715 -
Total liability 17,12,523 24,43,715 -
Source: MOFSL

Exhibit 13: Lower charge in the latter half would impact P&L positively
Particulars 31-Mar-20 31-Mar-19
Depreciation expense (4,79,391)
Finance Cost (2,68,809)
Operating Lease 10,00,000 (10,00,000)
Impact on Profit/(Loss) for the year 2,51,800 (10,00,000)
Source: MOFSL

April 2019 16
 Thematic | Ind-AS116-Lease

Exhibit 14: Effect of front loading of depreciation and interest expense would turn P&L account positive in later half (INR)
Lease PV of lease Cumulative lease Fin. P&L charge in P&L charge in
DF Dep.
Year payment liability liability at YE cost Ind AS116 Ind AS17
0 0 0 71,90,870
1 10,00,000 1.11 9,00,901 69,81,865 7,90,996 4,79,391 12,70,387 10,00,000
2 10,00,000 1.23 8,11,622 67,49,870 7,68,005 4,79,391 12,47,396 10,00,000
3 10,00,000 1.37 7,31,191 64,92,356 7,42,486 4,79,391 12,21,877 10,00,000
4 10,00,000 1.52 6,58,731 62,06,515 7,14,159 4,79,391 11,93,550 10,00,000
5 10,00,000 1.69 5,93,451 58,89,232 6,82,717 4,79,391 11,62,108 10,00,000
6 10,00,000 1.87 5,34,641 55,37,048 6,47,816 4,79,391 11,27,207 10,00,000
7 10,00,000 2.08 4,81,658 51,46,123 6,09,075 4,79,391 10,88,467 10,00,000
8 10,00,000 2.30 4,33,926 47,12,196 5,66,074 4,79,391 10,45,465 10,00,000
9 10,00,000 2.56 3,90,925 42,30,538 5,18,342 4,79,391 9,97,733 10,00,000
10 10,00,000 2.84 3,52,184 36,95,897 4,65,359 4,79,391 9,44,750 10,00,000
11 10,00,000 3.15 3,17,283 31,02,446 4,06,549 4,79,391 8,85,940 10,00,000
12 10,00,000 3.50 2,85,841 24,43,715 3,41,269 4,79,391 8,20,660 10,00,000
1,30,05,514* 1,20,00,000*
13 10,00,000 3.88 2,57,514 17,12,523 2,68,809 4,79,391 7,48,200 10,00,000
14 10,00,000 4.31 2,31,995 9,00,901 1,88,378 4,79,391 6,67,769 10,00,000
15 10,00,000 4.78 2,09,004 -0 99,099 4,79,391 5,78,490 10,00,000
Total 71,90,870 78,09,130 71,90,870 1,50,00,000 1,50,00,000
*Excess charge till date as per new Ind AS 116 has to charge directly to equity reserve 10,05,514 (1,30,05,514-1,20,00,000) Source: MOFSL

April 2019 17
 Thematic | Ind-AS116-Lease

Annexure IV – Full Retrospective approach

Assumptions:
 Original lease term: 15 years
 Remaining lease term: 3 years
 Date of application of new lease accounting standard: 1st Apr’19
 Incremental borrowing rate at the time of origination of lease: 10% P.A.

In the below illustrations, we have assumed interest rate on origination of lease

term as 10%. Therefore, finance cost is lower compared to the Modified
Retrospective approach. It is pertinent to note that finance cost and depreciation
expense would be affected based on the original lease term, phase of the lease term
at the time of application of this standard, and the borrowing rate at the time of
origination of the lease term.

Exhibit 15: Excess dep. and fin. cost vs annual lease exp. till date charged to equity (INR)
Particulars 31-Mar-20 31-Mar-19 01-Apr-18
Assets
Right of use asset 10,14,144 15,21,216 20,28,288
Total Asset 10,14,144 15,21,216 20,28,288

Equity
Other equity (6,46,262) (9,65,636) (11,41,578)
Total equity (6,46,262) (9,65,636) (11,41,578)

Liability
Lease liability 17,35,537 24,86,852 31,69,865
Total liability 17,35,537 24,86,852 31,69,865
Source: MOFSL

Exhibit 16: Lower charge in the latter half would impact P&L positively (INR)
Particulars 31-Mar-20 31-Mar-19 01-Apr-18
Depreciation expense (5,07,072) (5,07,072) (5,07,072)
Finance Cost (1,73,554) (2,48,685) (3,16,987)
Operating Lease 10,00,000 10,00,000 10,00,000
Profit/(Loss) for the year 3,19,374 2,44,243 1,75,941
Source: MOFSL

April 2019 18
 Thematic | Ind-AS116-Lease

Exhibit 17: Front loading of depreciation and interest expense would turn P&L account positive in the latter half (INR)
Cumulative
Lease DF PV of lease Fin. P&L charge in P&L charge in
Year lease liability Dep.
payment @10% liability cost Ind AS116 Ind AS17
at YE
0 0 0 76,06,080
1 10,00,000 1.10 9,09,091 73,66,687 7,60,608 5,07,072 12,67,680 10,00,000
2 10,00,000 1.21 8,26,446 71,03,356 7,36,669 5,07,072 12,43,741 10,00,000
3 10,00,000 1.33 7,51,315 68,13,692 7,10,336 5,07,072 12,17,408 10,00,000
4 10,00,000 1.46 6,83,013 64,95,061 6,81,369 5,07,072 11,88,441 10,00,000
5 10,00,000 1.61 6,20,921 61,44,567 6,49,506 5,07,072 11,56,578 10,00,000
6 10,00,000 1.77 5,64,474 57,59,024 6,14,457 5,07,072 11,21,529 10,00,000
7 10,00,000 1.95 5,13,158 53,34,926 5,75,902 5,07,072 10,82,974 10,00,000
8 10,00,000 2.14 4,66,507 48,68,419 5,33,493 5,07,072 10,40,565 10,00,000
9 10,00,000 2.36 4,24,098 43,55,261 4,86,842 5,07,072 9,93,914 10,00,000
10 10,00,000 2.59 3,85,543 37,90,787 4,35,526 5,07,072 9,42,598 10,00,000
11 10,00,000 2.85 3,50,494 31,69,865 3,79,079 5,07,072 8,86,151 10,00,000
12 10,00,000 3.14 3,18,631 24,86,852 3,16,987 5,07,072 8,24,059 10,00,000
1,29,65,636* 1,20,00,000*
13 10,00,000 3.45 2,89,664 17,35,537 2,48,685 5,07,072 7,55,757 10,00,000
14 10,00,000 3.80 2,63,331 9,09,091 1,73,554 5,07,072 6,80,626 10,00,000
15 10,00,000 4.18 2,39,392 0 90,909 5,07,072 5,97,981 10,00,000
Total 76,06,080 73,93,920 76,06,080 1,50,00,000 1,50,00,000
*Excess charge as per new Ind AS 116 has to be directly offset with equity reserve 9,65,636 (1,29,65,636-1,20,00,000) Source: MOFSL

April 2019 19
Explanation of Investment Rating
Investment Rating Expected return (over 12-month)
BUY >=15% Thematic | Ind-AS116-Lease
SELL < - 10%
NEUTRAL > - 10 % to 15%
UNDER REVIEW Rating may undergo a change
NOT RATED We have forward looking estimates for the stock but we refrain from assigning recommendation
* In case the recommendation given by the Research Analyst is inconsistent with the investment rating legend for a continuous period of 30 days, the Research Analyst shall within following 30 days take appropriate measures to make the recommendation consistent with the investment rating legend.

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to exempt MOSL or any of its affiliates or employees from, any and all responsibility/liability arising from such misuse and agrees not to hold MOSL or any of its affiliates or employees responsible for any such misuse and further agrees to hold MOSL
or any of its affiliates or employees free and harmless from all losses, costs, damages, expenses that may be suffered by the person accessing this information due to any errors and delays.
Registered Office Address: Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, Mumbai-400025; Tel No.: 022-3980 4263; www.motilaloswal.com. Correspondence Address: Palm Spring Centre, 2nd Floor, Palm
Court Complex, New Link Road, Malad (West), Mumbai- 400 064. Tel No: 022 3080 1000. Compliance Officer: Neeraj Agarwal, Email Id: na@motilaloswal.com, Contact No.:022-30801085.
Registration details of group entities: MOSL: SEBI Registration: INZ000158836 (BSE/NSE/MCX/NCDEX); CDSL: IN-DP-16-2015; NSDL: IN-DP-NSDL-152-2000; Research Analyst: INH000000412. AMFI: ARN 17397. Investment Adviser:
INA000007100.Motilal Oswal Asset Management Company Ltd. (MOAMC): PMS (Registration No.: INP000000670) offers PMS and Mutual Funds products. Motilal Oswal Wealth Management Ltd. (MOWML): PMS (Registration No.: INP000004409)
offers wealth management solutions. *Motilal Oswal Securities Ltd. is a distributor of Mutual Funds, PMS, Fixed Deposit, Bond, NCDs, Insurance and IPO products. * Motilal Oswal Real Estate Investment Advisors II Pvt. Ltd. offers Real Estate
products. * Motilal Oswal Private Equity Investment Advisors Pvt. Ltd. offers Private Equity products

*MOSL has been amalgamated with Motilal Oswal Financial Services Limited (MOFSL) w.e.f August 21, 2018 pursuant to order dated July 30, 2018 issued by Hon'ble National Company Law Tribunal, Mumbai Bench. The existing registration no(s) of
MOSL would be used until receipt of new MOFSL registration numbers.

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