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Treatment of Lease Transactions under Insolvency and Bankruptcy proceedings

– Devika Agrawal and Anshit Aggrawal, Executive  (resolution@vinodkothari.com)

The determination of the nature of debt has been one of the primary tasks before a Resolution Professional/ Liquidator, and also for the stakeholders. The classification of debt is an important consideration since there exist only two types of debt under the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “Code”), i.e., Operational Debt and Financial Debt, each with a significant set of rights and powers.

At the outset, one may think that the identification is a fairly simple job – loans and alike are financial debts, whereas those relating to supply of goods and services are operational in nature. Then, where does the confusion lie? The question of determination gains much importance for not-so-simple arrangements like lease transactions, which sit on the fence of being a financial transaction, and accordingly, the determination of financial versus operational nature will lead to consequent difference in rights and obligations.

In this article, the authors analyse the interface between the Code and lease transactions, and discuss the treatment of the leased assets or lease agreements/ transactions  under the Code.

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XaaSing of assets: Understanding essential differences between subscription and lease

-Vinod Kothari and Sikha Bansal (finserv@vinodkothari.com)

Just as you may subscribe to digital content, cellphone services, or software-as-a-service, you may subscribe to a car, or home durables. The business of availing equipment as a subscription is growing monotonic and steep, and currently, in the realm of passenger vehicles, it is already a rage. A report by BCG estimates that the subscription market for passenger vehicles may achieve a penetration of 15% of new car sales, and volumes of about USD 30 to 40 billion, by 2030[1].

This article seeks to touch upon the fundamental understanding of subscription and how it is different (or not different?) from a lease. There are several other similar contracts – which may be looking elusively similar – asset capacity sharing contracts, asset timeshare contracts, etc. Each of these might have shades of difference; however, our present write-up focuses on subscription services for assets, versus lease transactions.

What is “subscription”?

It is difficult to find a legal definition of the word “subscription” as the word is used in widely different contexts. “To subscribe” may mean to write your name or put your signature under a written document, (common example is ‘subscribing’ to a memorandum of a company). However, in the present context, the following dictionary  meaning of ‘subscription’ would become relevant: “A written contract by which one engages to contribute a sum of money for a designated purpose, either gratuitously, as in the case of subscribing to a charity, or in consideration of an equivalent to be rendered, as a subscription to a periodical, a forthcoming book, a series of entertainments, or the like.”[2]  Hence, a ‘subscriber’ is “a person who agrees to receive something on a regular basis, e.g. a newsletter, a newspaper, a delivery of goods, a subscriber to a mailing list.”

The context of this article is subscription to equipment – hence, the definition below from an Indiana law may be relevant: “‘subscription program’ means a subscription service that, for a recurring fee and for a limited period of time, allows a participating person exclusive use of a motor vehicle owned by an entity that controls or contracts with the subscription service. The term does not include leases, short term motor vehicle rentals, or services that allow short term sharing of a motor vehicle”. See, IND. CODE § 9-32-11-20(e) (2019)[3].

Under a vehicle subscription, a customer typically pays a “joining fee” plus a monthly subscription fee to have the right to use a vehicle from the company’s fleet of vehicles and to swap the vehicle for a different type of vehicle. Depending on the pricing tier, a customer may have unlimited swaps or may be limited to a certain number of swaps. A customer can initiate an exchange through the company’s mobile application, and the company will deliver the new vehicle and retrieve the vehicle currently in the customer’s possession. The company provides insurance coverage and access to roadside assistance and performs routine maintenance and repairs on the vehicles. See, House Bill, 537 (Northern California)[4] defining “vehicle subscription” for the purpose of applicability of alternative highway use tax.

Hence, one may define a subscription as follows:

A subscription contract is a contract where a subscriber avails a service, whether with or without a related asset, equipment or property, tangible or intangible, for a charge known as subscription fee, where the service provider agrees to provide, for a specified period, generally renewable at the option of the subscriber, a specific service. If an asset or equipment is put in the possession of the subscriber as a part of the service, the subscriber’s control over the same will be limited to the terms of the service, and generally, the service-provider shall have the ability to replace the same, whether for the purpose of a more effective service or otherwise.

Lease vs. subscription

The words lease, rent or hire mean the same thing – that is, transferring the right to use an asset. The act of ‘transferring’ right of use would mean that the lessee would have the exclusive right to use the asset and for that the asset as well as the control of the asset moves from the lessor to the lessee for the period of lease.

As one wonders, all of these would also happen in case of ‘subscription’ as discussed above; however, a fundamental difference is that, the customer’s intent in case of lease, is to have the ‘asset’ while in case of subscription, it is to have the ‘experience’ of the asset. Former is an ‘asset-oriented’ transaction, while the latter is a ‘service oriented’ transaction. Further, another important distinction lies in “commitment” to “an asset”. In a lease, the parties are committed to a particular asset identified at the beginning of the contract – replacements would only occur is the asset gets damaged or otherwise goes into an unusable state; however, inherent idea of ‘subscriptions’ is ‘choice’ and ‘flexibility’[5].

Hence, leases are different – differences are being tabulated below:

Point of Comparison Lease Subscription
Subject matter of the contract Transfer of right to use of an asset Provision of a service
Description of parties Lessor, lessee or renter Service Provider, Subscriber
Consideration Lease rentals or hire charges Subscription fee
Typical period Normally long enough to serve as an alternative mode of acquisition of an asset Normally short and flexible, such it is an alternative to acquisition itself. It focuses on experience, rather than acquisition
Identification of the asset Specifically identified Generically identified – such as a car of a particular type or category or class.
Ownership of the asset Throughout the term, remains with the lessor. EoT options may include an option to buy A subscription contract moves completely from the domain of asset acquisition – asset acquisition becomes irrelevant for a subscriber, as the subscriber continues to avail the service on a continuing/recurring basis
Provision of asset-related services by the owner Usually limited; however wet leases are also there Usually, the bundle of service makes it a service contract.
Control over the asset Remains with the lessee during the lease term Remains with the owner/service provider. Subscriber’s control is limited to what is required for the enjoyment of the service
Vehicle registration Normally, in the name of the lessee, with endorsement in the name of the lessor Normally, in the name of the lessor, under a rental contract
Vehicle number plate As in case of a private use vehicle, black colour in white background Commercial use- hence, black colour on yellow background
GST applicability A lease, being a transfer of right to use goods, is taxable at the same rate as applicable to the sale of the goods A subscription service, not involving a transfer of right to use, being a service, is taxable at the residual rate, viz., 18%
Asset recognition by customer Yes, as under the accounting standards No

Legal Implications

Legal classification of a transaction is important as the same would impact the legal rights and obligations of the parties.

Since a subscription is a bundle of services, it may also have elements of lease. A subscription is essentially a package; hence, the use of an asset is also embodied in a subscription. Hence, to the extent a subscription entails a right of using an asset, there is a bailment contract in a subscription too. Hence, bailment is a common feature of both leases and subscription contracts. Therefore, the rights and obligations of the bailor and bailee as per law of contracts may be applicable in case of subscription too.

Thus, from a broader perspective, both a lease and a subscription are forms of bailment contracts only as the possession passes to the customer. Hence, general contractual rules as are applicable to bailment contracts would apply in both the cases. Besides, from a legal perspective, the following may be noted  –

  • The supplier is the owner in both the cases, the customer only gets certain rights. In case of a lease, the customer is a conveyee of the right to use to the asset; however, in subscription, the customer only gets the right to use the service on payment of subscription fee. As such, supplier’s control on the asset in a subscription is higher than in a lease. Hence, vis-a-vis, the asset, the customer will have ‘better’ rights in a lease than in a ‘subscription’.
  • With respect to risk and rewards, as a lease transfers a right to use, a part of the risks and rewards (if not substantial) associated with the asset is transferred to the lessee. However, in a subscription, the risks and rewards would remain with the supplier, except that the contract would provide for normal liabilities in case of accidents, negligence, rash driving, unlawful use of the vehicle, etc.
  • Besides, there can be differences with respect to service and maintenance obligations. A subscription contract comes with bundled services; however, in lease, the obligations may pass to the lessee.

Note that due to the features as discussed above, in India, a subscription service may get covered under Rent a Cab Scheme, 1989. Thus, as under the Motor Vehicles Act and rules thereunder, the vehicle would be registered in the name of subscription provider and the number plate of the vehicle shall bear yellow alpha-numerals with black background registration mark. However, in case of leases, the vehicle would generally be registered in the name of the lessee, and shall bear black colour in white background.

Accounting perspective

For accounting purposes, does a subscription of an asset amount to a lease? If it does, the accounting standard on leases IFRS 16/ Ind AS 116 applies. The standard will require on-balance sheet treatment of the non-cancellable lease rentals in the books of the subscriber in most cases. Hence, the characterisation of the transaction as a “lease” for the purpose of the accounting standard becomes critical.

Ind AS 116 provides guidance on assessing whether a contract is a lease. A lease is defined in Para 9 as follows: “A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration” Therefore, there has to be a conveyance of the right to use an asset, which implies an identified asset.

In order for the contract to be a contract of lease:

  • there must be an identified asset;
  • the customer must have the right to direct use of the asset – where the supplier has substantive substitution rights (a combination of practical ability + economic benefits), the customer’s right to use is curtailed – see

It is notable that accounting standards quite often deviate from the legal form of the contract – hence, even if the legal form of the contract is a subscription, the accounting standards may still treat the contract as a lease. For example, IndAS 116, para B14 provides for the supplier to have substantive rights of substitution, that further, such right to be economically beneficial to the supplier.

Hence, for the purposes of accounting standards:

  • If the right of substitution or swapping the asset is with the subscriber, and not with the provider, such right is disregarded. That is to say, subject to other conditions, the transaction is still regarded as a lease.
  • If the right is right with the provider, that right has to be (i) substantive and practically implementable; (ii) The exercise of the right should be beneficial to the provider; (iii) the right should be available throughout the term of the lease; (iv) the substitution right should not be pertaining to such contingencies as the vehicle being under repairs, etc. As regards the economic benefits of the substitution rights, the economic benefits should be demonstrable without reference to uncertain future events. Further, since the vehicle is in possession of the subscriber, the provider will incur costs to replace the same – therefore, it should be clear that the benefits will outweigh such costs.
  • Assuming the conditions of substantive substitution rights as above are not satisfied, the contract may be regarded as one of lease, deviating from its legal nature. However, if the lease is within a term of 12 months, the provisions as to capitalisation of an RoU asset and OTP liability are not applicable to short term leases.

Hence, a typical subscription contract, which enables the subscription provider to provide service to the customer by using different vehicles (which belong to the preferred class/category chosen by the customer), it may be contended that the customer’s right to use is not perfected in such contracts. Further, given that the customer can ‘swap’ vehicles during the subscription period, it can be said that a subscription contract does not have an ‘identified asset’, per se.

Notably, accounting standards emphasise on substance over form. Hence, a pure subscription contract may not fall under Ind AS 116 (for reasons as above).

GST Implications

The GST law has different rates for motor vehicles. There are broadly 4 classes:

  • Hiring services (normally meaning the vehicle is under control of the hire vendor, and the hire vendor is running the asset on hire):
    • Transport of passengers by any motor vehicle designed to carry passengers where the cost of fuel is included in the consideration charged from the service recipient- GST rate is 5% (provided no ITC is availed by the supplier)
    • Transport of passengers by any motor vehicle designed to carry passengers where the cost of fuel is included in the consideration charged from the service recipient- GST Rate is 12%
  • Leasing or Rental services – indicating short term rentals: GST Rate is 18%
  • Transfer of right to use, that is, a service equivalent to sale of the same goods: Same GST rate as in case of sale of the goods with transfer of ownership [Refer, Notification No. 11/2017- dated 28th June, 2017[6]]

The GST rate on the various subscription models prevalent in the market varies and depends on the nature of transaction between the dealer and the end user. In our view, the subscription-based model is close to a rental service, and therefore, the rate will be 18%. Alternatively, if it is taken as an independent service the rate of tax is still 18%. On the question whether such a subscription service may be regarded as a ‘composite supply’, the tax rate on the principal supply shall determine the tax rate on the conjugate services. However, since the principle supply is still a lease or rental and not a transfer of right to use akin to purchase of the asset, the rate would still stand as 18%.

Closing remarks

It is not that subscription contracts per se  are a technological innovation, but the idea of an asset being converted into a subscription service is quite new, relative to the idea of leasing or hiring. Hence, the first predicament for one trying to state the law of subscription vs. lease is that there is no authoritative definition of a subscription, as compared to a lease.

The discussion is an attempt to identify key differentiators between lease and subscription. Essentially, a subscription contract is ‘service’ based while a lease is ‘asset’ based. However, classification of a particular contract would depend on the substance of the transaction rather than the form. A contract may be a subscription by name, but may have predominantly lease-type features. However, merely because a contract has some lease-type features would not lead to its classification as lease. Hence, one will have to assess what is the predominant flavour of the contract and of course, intent of the parties to the transaction to determine whether the contract is a lease or a subscription.

[1] https://www.bcg.com/en-in/publications/2021/how-car-subscriptions-impact-auto-sales

[2] https://dictionary.thelaw.com/subscription/

[3] https://law.justia.com/codes/indiana/2019/title-9/article-32/chapter-11/section-9-32-11-20/

[4] https://dashboard.ncleg.gov/api/Services/BillSummary/2019/H537-SMSV-44(e4)-v-2

[5] See an article titled “Insurers are Teaming up with Car Subscriptions”, published in CBInsights (2018). Per Porsche North America CEO Klaus Zellmer, younger people “do not want to engage with a commitment for three years. They want to change their phones; they want to change their TV channels. It’s all about subscriptions.”

[6] https://www.cbic.gov.in/resources//htdocs-cbec/gst/Notification11-CGST.pd

 

Our other articles on leasing:

https://vinodkothari.com/leasing/

https://vinodkothari.com/leashome/

https://vinodkothari.com/staff-publications-leasing/

Impairment in case of Lease Transactions

– Abhirup Ghosh (abhirup@vinodkothari.com)

Background

Like all assets, leased assets also undergo impairment. IAS 36 is the relevant standard for impairment of assets, however, IFRS 9 deals with impairment of financial assets, as well as lease receivables.

Therefore, even though lease transactions are governed by IFRS 16, for impairment of leased assets, one has to refer either of aforesaid standards.

In this article, we will focus on the manner in which leased assets are impaired, especially the way expected credit losses (ECL) could be calculated for lease transactions.

Approach

In the books of the Lessor

The approach of impairment differs with the nature of lease. In case of an operating lease, the lessor recognizes the asset under Property, Plant and Equipment. Therefore, the lease asset capitalized in the books of the lessor has to undergo impairment testing under IAS 36. In addition to that, the lease receivables that fall under the purview of IFRS 9 also have to be tested for impairment. In case of operating leases, only those rentals which are overdue shall undergo impairment testing under IFRS 9.

In case of financial leases, the lessor recognizes only lease receivables in its books. Therefore, there is no question of assessing impairment on the fixed asset in such case; only ECL has to be provided on the lease rentals.

In the books of the Lessee

Unlike the erstwhile standards on leasing, IFRS 16 provides for recognition of Right of Use (ROU) Asset in the books of the lessee, and a corresponding lease liability.

The ROU asset will also have to undergo impairment testing under IAS 36.

Impairment under IAS 36

The requirement to impair an asset under IAS 36 gets triggered only when any of the following indicators are noticed:

a.) External indicators:

  1. Significant decline in market value
  2. Change in technology, market, economic or legal environment
  3. Change in interest rate.
  4. Where the carrying amount is more than the market capitalization

b.) Internal indicators:

  1. Asset’s performance is declining
  2. Discontinuance or restructuring plan
  3. Evidence of physical obsolescence

The standard looks at assets Cash Generating Units, in case of lease transactions, each asset on lease would be treated as CGU for the purpose of this standard.

The impairment loss is calculated based on the carrying value of the asset and the recoverable value.

Recoverable value is the higher of the following:

a.) Fair value of the asset, less cost of disposal

b.) Value in use

Fair value of the asset is arrived at based on the valuation of the asset using appropriate valuation methodologies. From the fair value, cost of disposal has to be reduced, which includes:

  1. Legal costs
  2. Stamp duty and similar taxes
  3. Costs of removing the assets
  4. Incremental costs for bringing the assets into the conditions for its sale
  5. Other costs

The value in use computed based on the present value of all the future cash flows from the asset, discounted at rate which truly reflects the time value of money and the risks specific to the asset. To compute value in use, a risk weighted cash flows approach must be adopted.

There are two ways in which this approach can be adopted – a) by adjusting the cashflows, b) by adjusting the discounting rate.

In the first one, the future cash expected cash flows must be assigned different probabilities of recovery which would corroborate with the risk associated with the asset, and then discount the cash flows at the agreed yield of the transaction.

Alternatively, the instead of assigning probabilities of recovery on the cash flows, the original expected cash flows may be considered, however, the discounting rate may be adjusted to corroborate with the risks associated with the assets.

If the recoverable value of the asset is lower than the carrying amount, then the difference has to be booked as an impairment loss and the carrying amount has to be brought down to that extent.

Impairment under IFRS 9

There are two approaches for computing ECL:

  1. General Approach
  2. Simplified Approach

In the general approach, ECL is computed based on 12-months losses for instruments not showing significant increase in credit risk, and lifetime losses for instruments showing significant increase in credit risk.

In the simplified approach, ECL is computed based on lifetime losses on financial instruments, irrespective of whether it is showing significant increase in credit risk or not. This approach is mandatory for trade receivables not having a significant financing component. This approach is option for lease receivables and trade receivables having a significant financing component.

Therefore, for lease transactions, a reporting entity can opt for either of the two approaches.

General approach

Staging of financial instruments based on different risk categories is one of the key aspects of the general approach. There are three stages:

a) Stage 1 – A financial instrument is classified under Stage 1 at the inception of the transaction, unless the asset is credit impaired at the time of purchase. Subsequently, if the assets do not show significant increase in credit risk, they are classified under Stage 1.

b) Stage 2 – A financial instrument is classified under Stage 2, when it shows significant increase in credit risk. The credit risk on the reporting date is compared with the credit risk at the time of initial recognition.

c) Stage 3 – Lastly, if the financial asset shows objective evidence of impairment, the asset is credit impaired and classified as Stage 3.

For the purpose staging, the following considerations may be taken care of:

  1. Transition – In natural course, before a financial instrument becomes credit impaired or an actual default occurs, it should first show signs of significant increase in credit risk.
  2. Time to maturity – Time to maturity is an important indication of credit risk. For instance, a AAA bond has far more credit risk if the maturity is 10 years as compared 5 years. Therefore, while assessing the credit risk, the shortened remaining time to maturity must be considered. This logic however, may not hold good in case of transactions involving a balloon payment structure or a bullet payment structure, where the major part of the cashflows is concentrated towards the end of the tenure.
  3. What constitutes to be significant increase in credit risk – Usually the assessment of credit risk is left on the risk management division of the reporting entity, however, the standard states that if reasonable and supportable forward-looking information is available without undue cost or effort, an entity cannot rely solely on past due information when determining the credit risk. However, when information that is more forward-looking than past due status is not available without undue cost or effort, an entity may use past due information to determine the credit risk. There is a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due.

An entity can rebut this presumption if it has reasonable and supportable information that is available without undue cost or effort, that demonstrates that the credit risk has not increased significantly since initial recognition even though the contractual payments are more than 30 days past due. However, the Reserve Bank of India in its notification on Implementation of Indian Accounting Standards for NBFCs[1], has stated that in case, the reporting entity wishes to rebut the presumption, then clear justification must be documented, and such shall be placed before the Audit Committee of the Board. However, in any event the recognition of significant increase in credit risk should not be deferred beyond 60 days past due.

Further, when an entity determines that there have been significant increases in credit risk before contractual payments are more than 30 days past due, the rebuttable presumption does not apply.

Once the staging is complete the expected credit losses on the assets depending on their stage.

In case of Stage 1 assets, 12-months credit losses are provided. In case of Stage 2 and Stage 3 assets, lifetime credit losses are provided.

The difference between a Stage 2 and Stage 3 asset is that for the latter, the asset has to be impaired to the extent of the expected credit losses and the showed at net amount.

The graphic below summarises the general approach of ECL.

Simplified approach

In the simplified approach, the concept of staging does not apply. There is no requirement of assessment of significant increase in credit risk. Lifetime credit losses have to be provided.

This is optional for lease transactions, however, if the reporting entity wishes to adopt this approach, it has to be implemented separately on operating and financial leases.

Method of computing ECL on lease transactions

While computing ECL, operating lease and financial leases must be considered separately. While financial leases are financial transactions, hence, akin to loan transactions, operating leases are operating/ rental contracts. However, ECL, in the both cases, are done based on the future expected cash flows from the contract, that is the lease rentals.

The most appropriate approach of computing ECL in case of lease transactions in the “Loss Rate Approach”. In this approach, the ECL is computed based on the Probability of Defaults and Loss Given Defaults. The PD and LGD rates are applied on the Exposure at Default, and subsequently, discounted at the effective interest rate or the yield of the transaction.

Probability of Default

One of the most important components of computing ECL. For entities which follow Internal Risk Based Approach, this is usually an outcome of the IRB. However, where the reporting entity does not follow an IRB approach, a scorecard approach may be adopted for the same.

In a scorecard approach, various factors specific to the asset and the borrower are weighted to assess the credit risk and produce a PD level.

In case of lease transactions, besides the borrower specific factors, the experience in the asset class also must be given sufficient weightage. For example, personal use assets like cars, two-wheelers etc. may be assigned to a lower risk weight, whereas, for assets such as construction equipments, farming equipments, etc. where repayment of rentals depend on the generation of cash flows from the asset, may be assigned a higher risk weight.

Once the credit risk is assessed, the PD level has to be produced through:

  1. Vintage analysis of the assets to understand how default rates change over a period of time;
  2. Extrapolation of the trends, where the default information is not available for the maximum tenure of the exposure.

Usually, PD levels are representation of the performance of similar assets in the past, however, for ECL, a forward-looking approach has to be adopted, and accordingly the PD levels have to be calibrated to give a forward-looking effect.

Alternatively, a simpler approach may be adopted where the reporting entities may rely on internal benchmarking and external ratings to predict a PD level.

Loss Given Default

The loss given default signifies what proportion of the exposure, will actually be lost, should there be a default. The LGD rate is a function of the past trends of recovery of cash flows organically, and also the recovery from the underlying asset.

Therefore, LGD can be denoted as 1 – Recovery Rate.

For determining the LGD of a lease, the following may be considered:

  1. Forecasts of future cash flow recoveries,
  2. Forecasts of future valuation of the leased asset,
  3. Time to realization of the leased asset,
  4. Cure rates,
  5. External costs of realization of the leased asset.

The estimation of the aforementioned may be influenced by several factors, namely, the sector in which the asset is deployed, the geography, nature of asset etc.

Macroeconomic factors and the dependence of the aforesaid factors on the same must also be considered. For examples, situations like flood or drought would impact the recoverability of tractors. Similarly, situations like the pandemic COVID-19, would impact all of the aforesaid factors.

Exposure at Default

This reflects the exposure outstanding periodically for the entire tenure of the loan.

Discounting Rate

Usually, the effective interest rate of the transaction is used for discounting the cash flows and the credit losses.

Period

This refers to the contractual tenure of the facility. While determining the period, the ability of the customer to cancel or prepay, or the lessor’s ability to call the facility must also be considered.

The utilization of each of the factors for computation of ECL has been illustrated with the following numerical example:

Scheduled Cashflows Amort Schedule
Period Cash flows Interest Principal Closing POS
0  ₹ -1,00,000.00  ₹                       –  ₹                –  ₹ -1,00,000.00
1  ₹      25,000.00  ₹           7,930.83  ₹ 17,069.17  ₹     -82,930.83
2  ₹      25,000.00  ₹           6,577.10  ₹ 18,422.90  ₹     -64,507.93
3  ₹      25,000.00  ₹           5,116.01  ₹ 19,883.99  ₹     -44,623.94
4  ₹      25,000.00  ₹           3,539.05  ₹ 21,460.95  ₹     -23,162.98
5  ₹      25,000.00  ₹           1,837.02  ₹ 23,162.98  ₹                0.00
EIR 8%
Computation of ECL
Period EAD PD (Marginal) PD (Cumulative) LGD EIR Marginal ECL
0
1  ₹   1,00,000.00 3% 3% 20% 8%  ₹        555.91
2  ₹      82,930.83 3% 6% 20% 8%  ₹        427.15
3  ₹      64,507.93 3% 9% 20% 8%  ₹        307.84
4  ₹      44,623.94 4% 13% 20% 8%  ₹        263.07
5  ₹      23,162.98 4% 17% 20% 8%  ₹        126.52
12 Month’s ECL  ₹             555.91
Lifetime ECL  ₹          1,680.49

 

EIR Computed using IRR formula
PD and LGD Assumed numbers
Marginal ECL (PD*LGD*EAD)/(1+EIR)^Period

Conclusion

This article only tries to discuss one of the most commonly adopted approach for ECL computation. There could be several variations made to the aforementioned, or different approaches may be adopted. Ultimately, it is the management’s call to decide the approach which best suits the nature of the assets and the customers the entity is the dealing with.

Related articles on the Topic:

  1. Accounting for Lease Transactions
  2. New lease accounting standard kicks off from 1st April, 2019
  3. IMPLEMENTATION OF IFRS-16 IN VARIOUS COUNTRIES
  4. Lease accounting: Operating & Financial Lease distinction set to go from financial year 2019-20
  5. Comparative Analysis of changes in Standards on Leasing over time
  6. FAQs on Ind AS 116: The New Lease Accounting Standard

References:

  1. IFRS 9
  2. IFRS 16
  3. IAS 36
  4. Potential Impairments of Leased Assets and the Right-of-Use Asset under ASC 842 and IFRS 16
  5. Have lease assets become impaired?
  6. Leased Assets: Ongoing impairment considerations
  7. How does impairment look under IFRS 16?

[1] https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=11818&fn=14&Mode=0