Financial Reporting · Ind AS 116 Leases

Ind AS 116 Leases: Scope, Definition of a Lease and Identifying a Lease

Updated 5 October 2026 · Fact-checked

Under Ind AS 116, a lease is a contract, or part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. To solve a question, check whether an asset is identified, whether the supplier has a substantive substitution right, and whether the customer gets substantially all the economic benefits and directs the use. Then separate the lease components from non-lease components.

Understand Scope, Definition of a Lease and Identifying a Lease

A contract may be called a lease, a service agreement or a supply contract. Ind AS 116 ignores the label. It asks one question: does the contract give you the right to control the use of an identified asset for a period of time in exchange for consideration? If yes, it contains a lease and the customer (lessee) accounts for it under Ind AS 116.

There are two tests. First, is there an identified asset? An asset is usually identified by being specified in the contract, either explicitly (a serial number) or implicitly (the only asset that can meet the contract when it is made available to the customer). A capacity portion of an asset is also an identified asset if it is physically distinct, such as a floor of a building. A capacity portion that is not physically distinct, such as a share of a pipeline's capacity, is not identified unless it represents substantially all of the asset's capacity.

Second, does the customer control the use of it throughout the period? Control needs both rights: the right to obtain substantially all the economic benefits from use, and the right to direct the use. You direct use when you decide how and for what purpose the asset is used. Sometimes those decisions are predetermined. In that case, the lack of a decision right does not by itself rule out a lease. You still direct the use if you operate the asset (or the supplier cannot change the operating instructions), or if you designed the asset in a way that predetermines how and for what purpose it is used.

A substitution right can defeat the identified asset. If the supplier has the practical ability to substitute the asset throughout the period and would benefit economically from doing so, the right is substantive and there is no identified asset. Substitution rights that apply only on repair, or only when a technical fault occurs, are not substantive. If it is difficult to decide, assume the right is not substantive. Whether a substitution right is substantive is assessed at inception of the contract, and it is not reassessed afterwards, even if circumstances change (unless the terms and conditions of the contract are changed).

The standard applies to all leases, with scope exclusions. It does not apply to leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources; biological assets within Ind AS 41 held by a lessee; service concession arrangements within Appendix D of Ind AS 115; licences of intellectual property granted by a lessor within Ind AS 115; and rights held by a lessee under licensing agreements within Ind AS 38 for items such as films, patents and copyrights. A lessee may, but need not, apply the standard to leases of intangible assets other than those excluded rights. Recognition exemptions for short-term and low-value leases are covered in the lessee accounting topic.

Many contracts mix a lease with services, for example equipment hire with maintenance. You must split the consideration between lease and non-lease components. A lessee may elect, by class of underlying asset, not to separate and to treat each lease and associated non-lease components as a single lease component.

Key rules to remember

Definition of a lease: Lease = contract, or part of a contract, conveying the right to control the use of an identified asset for a period of time in exchange for consideration; Assess at inception of the contract. The assessment is reassessed only if the terms and conditions of the contract are changed.
Control of use (both needed): Right to obtain substantially all economic benefits + Right to direct the use = Control; Both must be held throughout the period of use. If use decisions are predetermined, the right to direct use is still met when the customer operates the asset or designed it so as to predetermine its use. So a lack of decision rights alone does not rule out a lease.
Substantive substitution right: Practical ability to substitute throughout the period + Supplier benefits economically from substitution = Substantive right; If substantive, there is no identified asset and no lease. Substitution only on repair or malfunction is not substantive. Assessed at inception and not reassessed afterwards.
Allocation to lessee's lease components: Price allocated to a lease component = Contract consideration × (Relative stand-alone price of the lease component ÷ Sum of stand-alone prices of all components); Stand-alone price is the price a supplier would charge separately. Use observable prices where available, otherwise estimate maximising observable information.
Practical expedient for lessee: Election by class of underlying asset: do not separate non-lease components; account for lease plus non-lease as one lease component; The fixed non-lease payments are then included in the lease liability, while variable payments are assessed on their own terms. Not available to lessors.

How to solve Scope, Definition of a Lease and Identifying a Lease questions

Use the same sequence for every 'is there a lease' question. Quote the paragraph logic and then apply it to the facts.

1Check scope first. Look for exclusions such as mineral rights, Ind AS 41 biological assets, service concession arrangements and Ind AS 115 licences of intellectual property.
2Test for an identified asset: is it specified explicitly or implicitly, and is it physically distinct or substantially all of a larger asset's capacity?
3Test the supplier's substitution right: can the supplier substitute throughout the period, and would it benefit economically? If both are true, there is no identified asset.
4Test the right to obtain substantially all the economic benefits from use throughout the period, including exclusive use and by-products.
5Test the right to direct the use: who decides how and for what purpose the asset is used? If decisions are predetermined, check who operates the asset or designed it.
6Conclude: lease or service contract. State the conclusion with the reason in one line.
7If there is a lease, identify the lease and non-lease components and allocate consideration on relative stand-alone prices, or apply the lessee practical expedient if elected.
8Note the consequences for the lessee in the answer, such as recognising a right-of-use asset and lease liability, subject to exemptions.

Quickest way: Four-question lease check

When to use it: Use for MCQs and for short case scenarios when you need a conclusion in a minute.

Q1: Is a specific asset identified (explicitly or implicitly, or a physically distinct portion)? If no, stop: no lease.
Q2: Can the supplier practically substitute the asset throughout the period and benefit from doing so? If yes, stop: no identified asset, so no lease.
Q3: Does the customer get substantially all the economic benefits of use for the whole period? If no, stop: no lease.
Q4: Does the customer direct how and for what purpose the asset is used? If decisions are predetermined, does the customer operate the asset or did it design the asset? If no to both, stop: no lease.
If all four checks are passed, it is a lease. Then check whether service elements exist and split by relative stand-alone price.

Common mistakes in Scope, Definition of a Lease and Identifying a Lease

Treating a contract as a lease because it is titled 'lease agreement', or as a service because it is titled 'service agreement'.
Students rely on the legal form of the document.
Fix: Apply the substance test: identified asset plus right to control use. Say that the title is not decisive.
Ignoring the supplier's substitution right when the asset is named in the contract.
Naming an asset looks like identification, so students stop there.
Fix: Always test substitution. A named asset is not identified if the supplier has a substantive right to substitute it throughout the period.
Treating a substitution right as substantive because it exists on paper.
Students overlook the two conditions of practical ability and economic benefit to the supplier.
Fix: Check both conditions. A right that is only exercisable on repair or malfunction, or where the supplier has no practical ability, is not substantive.
Treating the customer as controlling the asset only because it pays or uses it every day.
Students confuse using the asset with directing its use.
Fix: Check who makes the key decisions on how and for what purpose the asset is used. Where those are predetermined, check who operates or designed the asset.
Concluding there is no lease just because the customer has no say in how the asset is used.
Students treat the decision right as the only way to direct the use.
Fix: If use decisions are predetermined, check whether the customer operates the asset or designed it to predetermine its use. Either one still gives the right to direct the use.
Treating a portion of a larger asset, such as a share of pipeline capacity, as an identified asset.
Students assume any capacity portion qualifies.
Fix: A capacity portion is identified only if physically distinct or if it represents substantially all of the asset's capacity.
Allocating the contract price equally between lease and service components, or leaving non-lease items inside the lease.
Students forget the relative stand-alone price basis and the lessee election.
Fix: Allocate on relative stand-alone prices unless the lessee has elected the practical expedient for that class of asset. Remember lessors cannot use it.

Worked examples

Example 1

Alpha Ltd enters into a 5-year contract with Beta Logistics for the use of a specific warehouse floor (Floor 3, which is physically distinct) in Beta's building. Alpha uses the floor exclusively for its stock and decides what to store and when to access it. Beta has the right to move Alpha to another floor only if the building needs repair, and the cost of doing so would be high. Annual charge: ₹24,00,000. Does the contract contain a lease?

Show the solution

Scope: no exclusion applies. It is a contract for the use of a real property asset.
Identified asset: Floor 3 is specified and physically distinct, so it is an identified asset.
Substitution: Beta can move Alpha only for repair. This is not a substantive right, since the right is not exercisable throughout the period for Beta's economic benefit and it would be costly.
Economic benefits: Alpha uses the floor exclusively, so it obtains substantially all the economic benefits.
Direct the use: Alpha decides what to store and when to access it, so it directs how and for what purpose the floor is used.
Conclusion: all the conditions are met, so the contract contains a lease.

Answer: The contract contains a lease. Alpha, as lessee, accounts for it under Ind AS 116, subject to any recognition exemptions.

Example 2

Gamma Ltd contracts for 3 years with Delta Services for a hired machine plus maintenance. The machine is identified, Gamma controls its use, and the contract contains a lease. Total annual consideration is ₹10,00,000. Because Delta offers a bundle discount, the stand-alone prices, which add up to more than the contract price, are: machine hire ₹8,00,000 and maintenance ₹4,00,000 per year. Allocate the consideration. Then state the effect if Gamma elects the practical expedient.

Show the solution

Identify the components: machine hire is the lease component and maintenance is a non-lease component.
Sum of stand-alone prices = ₹8,00,000 + ₹4,00,000 = ₹12,00,000. This is more than the ₹10,00,000 contract price because of the bundle discount, which is shared in proportion to the stand-alone prices.
Lease component share = ₹8,00,000 ÷ ₹12,00,000 = 2/3. Allocation = ₹10,00,000 × 2/3 = ₹6,66,667 (rounded).
Non-lease component share = ₹4,00,000 ÷ ₹12,00,000 = 1/3. Allocation = ₹10,00,000 × 1/3 = ₹3,33,333 (rounded).
Check: ₹6,66,667 + ₹3,33,333 = ₹10,00,000, so it reconciles.
The lease payments used for the lease liability are ₹6,66,667 per year. The lease liability is the present value of these payments over the 3-year lease term, discounted at the rate implicit in the lease or, if that cannot be readily determined, Gamma's incremental borrowing rate. The maintenance part is accounted for under the applicable standard, usually as an expense when services are received.
If Gamma elects the practical expedient for this class of asset, it does not separate. The full ₹10,00,000 per year (all fixed here) is treated as lease payments and is included in the lease liability, again as a present value over the lease term at the same type of discount rate.

Answer: Allocate ₹6,66,667 per year to the lease and ₹3,33,333 per year to maintenance. The lease liability is the present value of the ₹6,66,667 annual payments over the lease term at the rate implicit in the lease or the incremental borrowing rate. With the practical expedient, the whole ₹10,00,000 per year is treated as lease payments for the lease liability.

Exam tips

Write the answer in provision, facts, conclusion form: cite the test, apply the facts, then state lease or no lease.
In case-scenario MCQs, look for the decisive detail: a substitution right for the supplier's benefit, a non-distinct capacity portion, or predetermined use decisions where the customer operates or designed the asset.
When asked about separation, show the relative stand-alone price working and a total check. Mention the lessee expedient and that it is by class of asset.
Always check scope exclusions in definition questions. Mineral rights, Ind AS 41 biological assets, service concession arrangements and Ind AS 115 IP licences sit outside Ind AS 116.
State that the assessment is made at inception and reassessed only if the contract terms change.

Practice questions from Ind AS 116 Leases

Scope, Definition of a Lease and Identifying a Lease in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Scope, Definition of a Lease and Identifying a Lease: frequently asked questions

What is the definition of a lease under Ind AS 116?

A lease is a contract, or part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. You need both an identified asset and control of its use by the customer.

When is a substitution right substantive?

It is substantive when the supplier has the practical ability to substitute the asset throughout the period of use and would benefit economically from doing so. If either condition fails, the substitution right is not substantive and does not prevent the asset from being identified.

Is a share of a capacity, such as a pipeline, an identified asset?

Only if the portion is physically distinct or represents substantially all of the capacity of the asset. A floor of a building is physically distinct. A proportion of a pipeline's capacity usually is not.

Must I always separate lease and non-lease components?

A lessee must allocate consideration on relative stand-alone prices unless it elects, by class of underlying asset, to treat lease and non-lease components as one lease component. A lessor cannot use this expedient and must allocate under Ind AS 115 principles.