Financial Accounting · Lease Accounting

Introduction to Leases and Ind AS 116 Basics for CMA Inter

Updated 10 October 2026 · Fact-checked

A lease is an agreement where the lessor gives the lessee the right to use an asset for an agreed period, in return for a payment or series of payments. To solve questions, find the lease term, then decide whether substantially all risks and rewards of ownership pass. If they do, it is a finance lease; otherwise, operating.

Understand Introduction to Leases and Ind AS 116 Basics

A lease is an agreement in which the lessor (owner) conveys to the lessee (user) the right to use an asset for an agreed period, in return for a payment or series of payments. Ownership is not the test. The right to use the asset for a period is the test.

The supplied standard text is AS 19 Leases, and this page follows it. Ind AS 116 is the later standard for entities that follow Ind AS. It treats leases from the lessee's side differently, and you should check which standard your paper question names. The basic terms below are common to both.

The lease term is the non-cancellable period for which the lessee has agreed to take the asset on lease, plus any further periods for which the lessee has an option to continue, with or without further payment, where it is reasonably certain at the inception of the lease that the lessee will exercise that option. A renewal option that the lessee is only likely to use, but is not reasonably certain to use, stays out of the lease term.

Two dates matter. The inception of the lease is when the terms are fixed, which is the earlier of the lease agreement date or the date the parties commit to the main terms. The commencement of the lease term is when the lessee is entitled to start using the asset. Classification is made at inception. Accounting entries start at commencement.

Leases are classified into two types. A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. An operating lease is a lease other than a finance lease. The legal title may or may not pass in a finance lease. The substance decides.

Key rules to remember

Lease: Lease = agreement + right to use an asset + agreed period + payment(s); All four elements must be present. The lessor conveys the right to use the asset to the lessee.
Lease term: Lease term = non-cancellable period + further periods under options that the lessee is reasonably certain to exercise at inception; Options that are merely possible are excluded. Cancellable periods are excluded unless covered by a reasonably certain option.
Finance lease: Finance lease = lease that transfers substantially all risks and rewards incident to ownership; Decided by substance, not by whether title passes.
Operating lease: Operating lease = any lease that is not a finance lease; Define it by exclusion. Do not look for separate tests.
Timing of classification: Classify at inception of the lease; A change in estimates (economic life, residual value) or circumstances (lessee default) does not change the classification.
Change in lease provisions: Changed terms that would have caused a different classification at inception = new agreement over its revised term; Renewing the lease does not count as such a change.
Lessee depreciation (finance lease): If ownership is not reasonably certain: depreciate fully over the shorter of lease term and useful life; The depreciation policy must be consistent with that for owned depreciable assets, following AS 10.
Lessee payments (finance lease): Lease payment = finance charge + reduction in outstanding liability; The finance charge produces a constant periodic rate on the remaining liability.

How to solve Introduction to Leases and Ind AS 116 Basics questions

Use this order for any introductory lease question, whether it asks for a definition, lease term or classification.

1Read the facts and confirm there is a lease: an agreement, an asset, the right to use it for an agreed period, and payment.
2Name the lessor and the lessee. Write the roles in your answer so the examiner sees them.
3Mark the dates: inception (terms fixed) and commencement (lessee can start using the asset).
4Compute the lease term: take the non-cancellable period and add only option periods the lessee is reasonably certain to exercise at inception.
5Classify at inception. Ask whether substantially all risks and rewards of ownership pass to the lessee. Yes means finance lease, no means operating lease.
6Check for later events. Changes in estimates or lessee default do not reclassify the lease. Changed terms that would have changed the classification create a new agreement.
7If asked for accounting, state the consequence: for a finance lease, depreciation plus finance charge in the lessee's books; for an operating lease, treat it as a simple rental arrangement.
8Write a one-line conclusion tying the classification to the facts.

Quickest way: Four-question lease check

When to use it: Use for MCQs and for the opening lines of a written answer when time is short.

Is there a right to use an asset for an agreed period against payment? If not, it is not a lease.
Lease term = non-cancellable period + reasonably certain options only.
Do substantially all risks and rewards pass? Yes means finance lease, no means operating lease.
Did something change after inception? Estimates or default change nothing. Changed terms that would alter the classification create a new agreement.

Common mistakes in Introduction to Leases and Ind AS 116 Basics

Treating a finance lease as one where legal title must pass to the lessee.
Students link finance leases with hire purchase, where ownership transfers.
Fix: Use the definition: the test is transfer of substantially all risks and rewards, whether or not title passes.
Adding every renewal option to the lease term.
Students read options as extra years without checking certainty.
Fix: Include an option period only if, at inception, it is reasonably certain the lessee will exercise it.
Reclassifying a lease because the residual value estimate or economic life changed.
Students think classification is reviewed every year.
Fix: Classification is made at inception. Changes in estimates or circumstances, such as lessee default, do not give a new classification.
Mixing up inception and commencement.
The two dates sound alike and often fall close together.
Fix: Inception fixes the terms and is the classification date. Commencement is when the lessee can begin to use the asset.
Defining an operating lease with its own list of conditions.
Students try to memorise a mirror-image list.
Fix: Write it as the standard does: an operating lease is a lease other than a finance lease.
Applying AS 19 wording to a question that names Ind AS 116, or the reverse.
Both standards are called lease standards and share terms.
Fix: Check the standard named in the question. Use the finance and operating split for AS 19 questions, and state the standard you are following in your answer.

Worked examples

Example 1

Meera Textiles Ltd takes a machine on lease from Kaveri Finance Ltd. The non-cancellable period is 3 years. Meera has an option to continue for 2 more years at a nominal rent, and at inception it is reasonably certain that Meera will exercise it. Meera also has a separate option to extend for another 1 year at a market rent, which it may or may not use. Find the lease term and name the lessor and lessee.

Show the solution

Lessor: Kaveri Finance Ltd, the owner who conveys the right to use. Lessee: Meera Textiles Ltd, the user.
Non-cancellable period = 3 years.
The 2-year option is reasonably certain to be exercised at inception, so it is included.
The 1-year market-rent option is only possible, not reasonably certain, so it is excluded.
Lease term = 3 + 2 = 5 years.

Answer: Lease term is 5 years. Kaveri Finance Ltd is the lessor and Meera Textiles Ltd is the lessee.

Example 2

Arjun Engineering Ltd leases equipment costing ₹6,00,000 for 4 years. The lease transfers substantially all risks and rewards of ownership to Arjun, so it is a finance lease. The useful life is 5 years, and ownership will not pass at the end of the term. After two years the lessor's estimate of the residual value changes. (a) Classify the lease and say whether the change affects it. (b) Find the yearly depreciation on the ₹6,00,000 asset, assuming that value is recognised.

Show the solution

(a) Substantially all risks and rewards pass, so the lease is a finance lease, decided at inception.
A change in the estimate of residual value is a change in estimate. It does not give rise to a new classification.
(b) There is no reasonable certainty that ownership will pass, so the asset is fully depreciated over the shorter of lease term and useful life.
Lease term is 4 years and useful life is 5 years. The shorter period is 4 years.
Yearly depreciation = ₹6,00,000 ÷ 4 = ₹1,50,000 (straight-line, assumed as the method).

Answer: The lease stays a finance lease. Yearly depreciation is ₹1,50,000 over 4 years.

Exam tips

For definition questions, quote the key words: right to use an asset, agreed period, payment or series of payments, and substantially all risks and rewards.
In lease-term numericals, state which options you include and why. The words 'reasonably certain' earn the mark.
Write the classification date. Say 'classified at inception' so the examiner sees you know changes in estimates do not reclassify.
Name the standard you are applying, AS 19 or Ind AS 116, in the first line of a written answer.
In MCQs, watch for options saying title must pass or that estimates trigger reclassification. Both are wrong under the standard.

Practice questions from Lease Accounting

Introduction to Leases and Ind AS 116 Basics in other exams

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

CMA FinalIntroduction to Leasing and Types of Leases

Introduction to Leases and Ind AS 116 Basics: frequently asked questions

What is a lease in simple words?

A lease is an agreement in which the owner, the lessor, lets another party, the lessee, use an asset for an agreed period in return for payment. The owner may keep legal title. What the lessee buys is the right to use.

What is the difference between a finance lease and an operating lease?

A finance lease transfers substantially all the risks and rewards incident to ownership of the asset. An operating lease is any lease that is not a finance lease. The decision is made at inception, by the substance of the deal.

What is the difference between inception date and commencement date?

Inception is when the lease terms are fixed, and classification is made then. Commencement of the lease term is when the lessee is entitled to start using the asset. Accounting entries begin from commencement.

Is the lease term always the same as the agreement period?

No. The lease term is the non-cancellable period plus further periods under options that the lessee is reasonably certain to exercise at inception. Cancellable periods and unlikely options are left out.