Nova Retail Ltd. (NRL), a listed company, entered into a 5-year lease for a retail premises on 1 April 20X1, with an option to extend it for another…

Determination of the lease term under Ind AS 116 Under Ind AS 116, the lease term inter alia includes the period covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and Therefore, the fact that the extension is legally optional does not by itself mean that the extension period must be excluded. In the present case, following factors indicate a strong economic incentive and provide significant evidence that NRL may be reasonably certain to exercise the extension option: substantial expenditure has been incurred on customised leasehold improvements; the improvements are not readily transferable to another location; the store is highly profitable; long-term supply and marketing arrangements are linked to the premises; the business plan assumes continued operation; the renewal rental appears commercially attractive; and the Board has approved future capital expenditure relating to the store. Therefore, the conclusion should not be based merely on whether the option has been formally exercised. (i) Accounting of lease: Since it is reasonably certain to exercise the extension option, the extension period would form part of the lease term. Consequently, the lease liability and right-of-use asset should be determined using the applicable lease term and measurement requirements under Ind AS 116. If circumstances change such that the lease term needs to be reassessed, the lease liability may need to be remeasured, with the corresponding adjustment generally made to the right-of-use asset, subject to the requirements of Ind AS 116. Therefore, excluding the extension merely to avoid increasing reported liabilities would not be appropriate since the underlying facts support the conclusion that NRL is reasonably certain to exercise the option. (ii) Professional ethics: Several fundamental principles are relevant. Integrity: CA Ananya must be straightforward and honest in preparing financial information. She should not knowingly support an accounting treatment that does not appropriately reflect the requirements of Ind AS 116. Objectivity: Ananya should exercise independent professional judgment and should not allow the CFO's concern regarding leverage ratios to influence the accounting conclusion. The desired impact on the company's financial ratios is not a criterion under Ind AS 116. Professional competence and due care: Ananya must have sufficient knowledge of Ind AS 116 and carefully evaluate all relevant facts and circumstances before reaching a conclusion. She cannot simply accept management's argument: Professional behaviour: Ananya should comply with applicable Ind AS and avoid conduct that could bring discredit to the profession. (iii) Appropriate course of action: Ananya should obtain sufficient evidence and review the documents related to Lease contract and perform an independent assessment as to whether the available facts establish that NRL is reasonably certain to exercise the extension option. She should communicate to the management that the assessment under Ind AS 116 is based on the relevant economic incentives and circumstances, rather than simply whether the option has been formally exercised. CA Ananya should not allow the desired effect on the company's financial ratios to determine the accounting treatment. Management may choose its business strategy, but it cannot choose an accounting conclusion merely because that conclusion produces a preferred financial result. If management refuses to make the appropriate accounting adjustment, CA. Ananya should escalate the matter to the appropriate level and, where appropriate, those charged with governance/Audit Committee. (iv) Consequences of failure to discharge professional responsibility: In case CA Ananya succumbs to the undue influence of the CFO and knowingly approves an accounting treatment that is not in accordance with Ind AS, she may be liable for professional misconduct under Clause 1 of Part II of the Second Schedule to the Chartered Accountants Act, 1949. The Clause 1 states that a member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct, for contravening the provisions of this Act or the regulations made thereunder or any guidelines issued by the Council. As per the Guidelines issued by the Council, a member of the Institute who is an employee shall exercise due diligence and shall not be grossly negligent in the conduct of his duties.