The short-term lease exemption gets misapplied because the actual test — whether the lease term at commencement is 12 months or less — gets replaced in practice with a much easier, wrong question: how much time is left on the lease right now. A five-year lease that happens to have eight months left before renewal is not a short-term lease under Ind AS 116 no matter how little time remains; it was never short-term at commencement, and renewal options reasonably certain to be exercised have to be folded into the lease term assessment from day one, not re-assessed casually at each reporting date.
Where this specifically goes wrong
- A lease with an auto-renewal clause gets treated as short-term each renewal cycle because each individual renewal period is under 12 months, ignoring whether renewal is reasonably certain and the real lease term is much longer.
- A month-to-month arrangement that has, in substance, continued for years without interruption gets exempted every period on the basis of its nominal notice period rather than its demonstrated actual duration.
- Leases entered into near a reporting date get assessed against time remaining to year-end instead of the full term from commencement.
- A purchase option embedded in the lease is overlooked, when its presence alone disqualifies a lease from the short-term exemption regardless of the stated term.
- The exemption is applied by asset class as a blanket policy without checking that every individual lease within that class actually meets the 12-month test.
Regulatory requirement
Ind AS 116 defines the short-term lease exemption by reference to the lease term at commencement, including renewal periods reasonably certain to be exercised, and specifically excludes any lease containing a purchase option — regardless of how long the elapsed term or the remaining period is at any later date.
What the misapplication actually costs
A lease wrongly kept off the balance sheet understates both the right-of-use asset and the lease liability, and overstates operating profit by replacing depreciation and interest with a flat rental expense. The fix isn't a one-time true-up — it's re-checking the lease term assessment for every lease treated as exempt, against the actual commencement terms rather than the time remaining today.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Fixed assets & capexLease accounting audit under Ind AS 116: what changedHow the right-of-use asset and lease liability are recognised, testing the discount rate and lease term, the exemptions that still exist, and the errors that recur most often.
- Fixed assets & capexCapex vs revenue expenditure: the audit testThe capitalisation criteria, the repairs-versus-improvement judgement calls that actually come up, and how to sample repairs and maintenance for misclassified capex.
- Audit documentationInd AS 1: presentation of financial statements, and what a complete set actually requiresFour statements plus notes isn't optional structure — Ind AS 1 defines exactly what counts as a complete set, and a financial statement missing one piece isn't compliant regardless of how good the other three look.
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