Ind AS on Intangible Assets, Investment Property and Leases — Practice

Question 1

A pharmaceutical company incurs ₹40 lakh on a new drug formulation project. At the point the drug enters late-stage clinical trials, management can demonstrate technical feasibility, intention to complete and sell the drug, an identified market for it, and adequate financial and technical resources to complete the project, and can reliably measure the expenditure attributable to it, but regulatory approval — necessary before the drug can actually be sold — has not yet been obtained. Determine whether the ₹40 lakh, or any part of it, can be capitalised as an intangible asset, applying all six Ind AS 38 criteria.

Accepted Answer

Ind AS 38 requires all six criteria to be demonstrated simultaneously before development expenditure can be capitalised: technical feasibility of completing the asset (satisfied — technical feasibility is demonstrated); intention to complete and use or sell the asset (satisfied — management intends to complete and sell the drug); ability to use or sell the intangible asset (this is where the fact pattern raises a genuine question, since regulatory approval, a prerequisite to actually selling the drug, has not yet been obtained, meaning the company cannot yet demonstrate its ability to sell it); how the asset will generate probable future economic benefits, including the existence of a market (satisfied — an identified market exists); availability of adequate technical, financial and other resources to complete the project (satisfied); and the ability to reliably measure the expenditure attributable to the asset during development (satisfied). Because the 'ability to use or sell' criterion is not yet demonstrably satisfied given the absence of regulatory approval, all six criteria are not simultaneously met, and the ₹40 lakh should continue to be expensed as incurred rather than capitalised, even though five of the six criteria are otherwise satisfied — Ind AS 38 requires all six, not a majority, and expenditure remains ineligible for capitalisation until every one of them can genuinely be demonstrated.

Question 2

A company spends ₹25 lakh over several years building up a strong, well-recognised brand name through advertising and marketing, entirely through its own internal efforts with no separate brand acquired from a third party. Explain whether this ₹25 lakh, or any resulting brand value, can be recognised as an intangible asset.

Accepted Answer

No — Ind AS 38 explicitly and specifically prohibits recognising internally generated brands, along with mastheads, publishing titles, customer lists and similar items in substance, as intangible assets, regardless of how much expenditure has been incurred building them up or how valuable the resulting brand genuinely is in the market. The reasoning is that expenditure of this kind, advertising and marketing spend building general brand recognition over time, cannot be reliably distinguished from the broader cost of developing the business as a whole; there is no way to isolate a specific, identifiable cost of 'the brand' separate from the general costs of running and promoting the business, which fails the reliable measurement and separate identifiability that recognition requires. The ₹25 lakh spent must therefore be expensed as incurred, as advertising and marketing expense, in each period it is incurred, and no intangible asset for the brand can ever be recognised on the balance sheet purely from this internally generated build-up, however commercially valuable the resulting brand has genuinely become.

Question 3

A company acquires a taxi operating licence that is renewable indefinitely at negligible cost, provided the company continues to meet certain conditions it expects to meet for the foreseeable future, with no foreseeable limit on the period the licence is expected to generate cash flows. Explain how this intangible asset should be treated for amortisation and impairment purposes.

Accepted Answer

Since there is no foreseeable limit to the period over which the licence is expected to generate net cash inflows for the company, and renewal is achievable at negligible cost with conditions the company reasonably expects to continue satisfying, the licence has an indefinite useful life, which is a distinct concept from simply having a long or renewable life — the key test is whether there is genuinely no foreseeable limit, not merely a long or uncertain limit. An intangible asset with an indefinite useful life is not amortised at all, since amortisation would systematically allocate a cost over a life the entity does not actually expect to be limited, but is instead tested for impairment at least annually, and whenever there is an indication that it may be impaired, exactly mirroring the treatment goodwill receives; if circumstances later change such that the licence's useful life is no longer considered indefinite, for instance if renewal became genuinely uncertain or newly restricted, the change would be accounted for as a change in accounting estimate, requiring the asset to begin being amortised prospectively over its newly assessed finite useful life.

Question 4

A manufacturing company owns a building, one floor of which it uses as its own head office, and the remaining floors of which are leased out to unrelated third parties under operating leases. Explain how this building should be classified and accounted for under Ind AS 40.

Accepted Answer

Where portions of a property can be sold separately, or leased out separately under a finance lease, the portion held to earn rentals (the leased-out floors) is accounted for separately as investment property, while the portion used by the entity itself (the head office floor) is accounted for as owner-occupied property under Ind AS 16, provided these portions could genuinely be sold or leased out separately; if the portions cannot be sold separately, the property is treated as investment property only if an insignificant portion is held for use in the production or supply of goods or services or for administrative purposes, otherwise the whole property is treated as owner-occupied. Here, since one floor is used as head office and the remaining floors are leased to unrelated third parties, and assuming the floors could be sold or leased separately, the leased-out floors are recognised and measured as investment property under Ind AS 40, using either the cost model or the fair value model consistently applied to all the company's investment property, while the head office floor remains within PPE under Ind AS 16, measured under whichever model, cost or revaluation, the company applies to that class of assets.

Question 5

A company holds investment property under the fair value model. Its property's fair value increases from ₹200 lakh to ₹230 lakh during the year. Explain how this change is recognised, and why no separate depreciation charge is recorded for the year.

Accepted Answer

Under the fair value model, the ₹30 lakh increase in fair value is recognised directly in profit or loss for the period, not through other comprehensive income as a revaluation surplus would be under Ind AS 16's revaluation model for owner-occupied PPE; this is a deliberate and distinguishing feature of Ind AS 40's fair value model, reflecting that investment property is held essentially as an investment asset, so changes in its value are treated as part of the entity's ordinary operating or investment performance for the period rather than as a separate equity reserve movement. No separate depreciation charge is recorded because investment property measured under the fair value model is explicitly not depreciated at all under Ind AS 40; the annual fair value remeasurement itself already captures the net effect of any physical wear, obsolescence, or market movement on the property's value each period, so a separate depreciation charge alongside the fair value remeasurement would effectively double-count the reduction in value that ageing or wear might otherwise cause.

Question 6

A company enters into a contract to use a specific truck for two years, but the supplier retains the practical ability to substitute the truck with another of similar specification at any time during the contract, and would genuinely benefit economically from doing so (for example, to service the truck or reallocate it to a more urgent customer need), and would exercise this right in practice. Determine whether this arrangement meets the Ind AS 116 definition of a lease.

Accepted Answer

A contract conveys the right to control the use of an identified asset only where the asset is not subject to a substantive substitution right held by the supplier; a substitution right is substantive only where the supplier has the practical ability to substitute the asset throughout the period of use and would genuinely benefit economically from exercising that right. Here, the supplier both has the practical ability to substitute the truck and would genuinely benefit economically from doing so, and the facts state the supplier would exercise this right in practice, meaning the substitution right is substantive. Because a substantive substitution right means the underlying truck is not an identified asset, one of the two core requirements for a lease under Ind AS 116, this arrangement does not meet the definition of a lease at all, and should instead be accounted for as a service contract, with payments simply expensed as incurred rather than giving rise to a right-of-use asset and lease liability.

Question 7

A lessee enters a five-year lease for equipment, with annual lease payments of ₹20 lakh payable at the end of each year, and the lessee's incremental borrowing rate is 10% per annum (present value annuity factor for 5 years at 10% is 3.791). The lessee also incurs ₹3 lakh of initial direct costs. Compute the lease liability and the right-of-use asset at commencement.

Accepted Answer

Lease liability at commencement = Present value of the five annual lease payments of ₹20 lakh each, discounted at 10% = ₹20 lakh × 3.791 = ₹75.82 lakh. Right-of-use asset at commencement = Lease liability ₹75.82 lakh + initial direct costs ₹3 lakh (no lease payments made at or before commencement and no restoration cost estimate or lease incentives given in the facts) = ₹78.82 lakh. Going forward, the lease liability is subsequently measured using the effective interest method, with interest expense recognised in profit or loss based on 10% of the outstanding liability balance each year, separately from the right-of-use asset's depreciation charge, which would typically be computed on a straight-line basis over the shorter of the five-year lease term and the equipment's own useful life, this being the standard two-charge pattern — interest plus depreciation — that Ind AS 116 requires lessees to recognise in place of the single straight-line operating lease expense that applied before this standard's introduction.

Question 8

Explain why Ind AS 116 retains the finance/operating lease distinction for lessor accounting even though it abolished the equivalent distinction for lessees, and name two indicators used to classify a lease as a finance lease from the lessor's perspective.

Accepted Answer

Ind AS 116 abolished the operating/finance lease distinction specifically for lessee accounting because the standard-setters concluded that a lessee obtains a genuine, recognisable right to use an asset under virtually every lease, regardless of how that lease happens to be classified, making a single, unified on-balance-sheet model for lessees more faithfully representative than the prior approach, which allowed most leases to stay entirely off-balance-sheet as operating leases. For lessors, however, the underlying economics genuinely differ depending on whether substantially all the risks and rewards of ownership have been transferred to the lessee: a finance lease lessor has, in substance, sold the use of the asset and is left holding a financial receivable, while an operating lease lessor has retained substantially all the risks and rewards of ownership and continues to hold a genuine asset that it is merely renting out, a distinction that remains economically meaningful and is retained. Indicators used to classify a lease as a finance lease from the lessor's perspective include the lease transferring ownership of the underlying asset to the lessee by the end of the lease term, and the lessee having an option to purchase the asset at a price expected to be sufficiently lower than fair value at the date the option becomes exercisable, such that it is reasonably certain the option will be exercised; other indicators include the lease term being for the major part of the asset's economic life, and the present value of the lease payments amounting to substantially all of the asset's fair value at inception.

Question 9

Explain the two alternative ways an intangible asset can satisfy the 'identifiability' recognition criterion under Ind AS 38, and give an example of an asset satisfying each alternative independently.

Accepted Answer

An intangible asset satisfies the identifiability criterion if it is either separable, meaning it is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability, or if it arises from contractual or other legal rights, regardless of whether those rights are themselves transferable or separable from the entity or from other rights and obligations. A customer list acquired from another business, which could in principle be sold or licensed to another party, satisfies identifiability through the separability route, without necessarily arising from any specific legal right. A licence granted by a government authority to operate in a regulated industry, which may not be legally transferable to another party at all, still satisfies identifiability through the legal rights route, since it arises from a specific, identifiable contractual or legal right, even though it fails the separability test entirely; either route independently is sufficient to satisfy the identifiability criterion.

Question 10

Explain the circumstances under which an intangible asset with a finite useful life can be assigned a non-zero residual value for amortisation purposes.

Accepted Answer

Ind AS 38 requires the residual value of an intangible asset with a finite useful life to be assumed to be zero unless a third party has committed to purchase the asset at the end of its useful life, or there is an active market for the asset from which residual value can be determined and it is probable that such a market will exist at the end of the asset's useful life. This is a deliberately restrictive test, since intangible assets, unlike many tangible assets, rarely have an active resale market or a specific third-party purchase commitment at the outset; absent one of these two specific circumstances being satisfied, the full cost of the intangible asset, less any impairment, is amortised down to zero over its useful life, rather than being amortised only down to an assumed but unsupported residual value, which would understate the periodic amortisation charge without adequate justification.

Question 11

A company is constructing a building that it intends to lease out entirely to third parties once complete, and has applied the fair value model to its existing investment property. Explain how the building under construction should be classified and measured during the construction period.

Accepted Answer

Property being constructed or developed for future use as investment property falls within the scope of Ind AS 40 as investment property under construction, provided the future use, once complete, will genuinely be to earn rentals or for capital appreciation rather than owner-occupation; it is not treated as ordinary PPE under construction merely because it is not yet complete or generating rental income. Where the entity applies the fair value model to its investment property, that same fair value model is applied to investment property under construction as well, and the property is measured at fair value if fair value can be reliably determined, with changes in fair value recognised in profit or loss, consistent with the entity's policy for its completed investment property; if the fair value of the property under construction cannot yet be reliably determined, for instance very early in construction before enough information exists to support a reliable estimate, it is measured at cost until either its fair value becomes reliably determinable or construction is complete, whichever is earlier, at which point the fair value model resumes being applied and any difference between cost and fair value at that point is recognised in profit or loss.

Question 12

A lessee receives a lease incentive of ₹5 lakh from the lessor at the commencement of a lease, as a contribution toward the lessee's fit-out costs. Explain how this incentive affects the initial measurement of the right-of-use asset.

Accepted Answer

Ind AS 116 requires lease incentives received to be deducted in arriving at the initial cost of the right-of-use asset; the right-of-use asset is measured at the amount of the initial lease liability, plus lease payments made at or before commencement, plus initial direct costs incurred by the lessee, plus an estimate of restoration costs where applicable, less any lease incentives received. The ₹5 lakh incentive received here therefore directly reduces the initial carrying amount of the right-of-use asset by ₹5 lakh compared to what it would otherwise have been, reflecting that the lessee's genuine net cost of obtaining the right to use the asset is lower once this incentive contribution from the lessor is taken into account, rather than the incentive being recognised separately as a form of income unrelated to the asset's initial measurement.

Question 13

A lessee enters a lease for office equipment with an initial term of 11 months, and the lease includes an option to extend for a further 6 months that the lessee is reasonably certain to exercise. Explain whether this lease qualifies for the short-term lease exemption under Ind AS 116.

Accepted Answer

The short-term lease exemption applies to a lease that, at the commencement date, has a lease term of 12 months or less, and the lease term for this purpose must include any period covered by an extension option that the lessee is reasonably certain to exercise, not merely the initial, stated contractual term. Since the lessee is reasonably certain to exercise the 6-month extension option, the lease term for Ind AS 116 purposes is 11 months plus 6 months, 17 months in total, which exceeds the 12-month threshold; this lease therefore does not qualify for the short-term lease exemption, despite its initial stated term of 11 months being under 12 months on its own, and the lessee must recognise a right-of-use asset and lease liability for the full 17-month lease term rather than expensing the payments on a straight-line basis as a short-term lease exemption would otherwise permit.

Question 14

A company sells a building to a buyer for ₹10 crore, its fair value, and simultaneously leases it back for 8 years. The transaction satisfies Ind AS 115's requirements to be accounted for as a sale. Explain, in outline, how the seller-lessee should account for this transaction, distinguishing it from a straightforward sale with no leaseback.

Accepted Answer

Where a sale and leaseback transaction satisfies Ind AS 115's requirements to be accounted for as a genuine sale of the underlying asset, the seller-lessee does not recognise the entire gain on sale immediately, unlike in a straightforward sale with no leaseback where the full gain would typically be recognised at once; instead, because the seller retains a right to use the asset through the leaseback arrangement, only the gain relating to the rights transferred to the buyer-lessor, that is, the portion of the asset the seller no longer has a right to use, is recognised at the date of the transaction, while the gain relating to the right-of-use retained by the seller through the leaseback is not recognised immediately, since the seller-lessee has not, in substance, disposed of the entire economic benefit of the asset given it continues to use it under the leaseback. The seller-lessee recognises a right-of-use asset arising from the leaseback, measured as the proportion of the previous carrying amount of the asset that relates to the right of use retained, and a lease liability for the leaseback payments, meaning the transaction is split analytically into the portion that is a genuine, fully recognised sale, and the portion that is, in substance, a continued right of use financed through the leaseback arrangement, which is precisely the distinction that would not arise at all in a straightforward sale with no leaseback, where the seller retains no further right to use the asset at all.

Question 15

A lessee originally assessed that it was not reasonably certain to exercise a lease extension option and excluded that extension period from the lease term at commencement. Two years into the lease, a significant leasehold improvement investment makes it now reasonably certain the lessee will exercise the extension. Explain how this should be treated under Ind AS 116.

Accepted Answer

Ind AS 116 requires a lessee to reassess the lease term upon the occurrence of a significant event or significant change in circumstances that is within the lessee's control and affects whether the lessee is reasonably certain to exercise an extension option, and a substantial leasehold improvement investment that would only make economic sense if the lease is extended is precisely this kind of significant change in circumstances within the lessee's control. On reassessment, the lease term is revised to reflect the now reasonably certain extension, and both the lease liability and the right-of-use asset are remeasured to reflect the revised lease term, using a revised discount rate as at the date of reassessment; this remeasurement is prospective from the point of reassessment, adjusting the right-of-use asset and lease liability going forward to reflect the newly extended lease term, rather than retrospectively restating the accounting applied in the two years since commencement, since the original assessment was reasonable given the information and circumstances that existed at that earlier time.

Practice — Ind AS on Intangible Assets, Investment Property and Leases

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