1. Why Security Deposits Need Special Accounting Under IND AS
Under the old IGAAP (Indian GAAP), a security deposit paid to a landlord was simply booked at the amount paid and shown as an asset. No discounting. No interest income. No Day 1 expense. Simple — but economically incorrect.
IND AS 109 (aligned with IFRS 9) changes this fundamentally. A security deposit is an interest-free loan to the lessor. When you pay ₹10 lakhs as a refundable deposit for 3 years and receive ₹0 interest on it, you are giving the lessor a below-market financial arrangement. The economic cost of that lost interest is real and must be recognised.
Key principle: Under IND AS 109, all financial instruments must be initially recognised at fair value. For a zero-interest security deposit, fair value = present value of future cash flows (the refund amount) discounted at the market rate.
Who this applies to: Companies following IND AS — primarily listed companies, companies with net worth > ₹250 crore, and their subsidiaries. If you follow IGAAP (AS), IND AS 109 does not apply to you.
2. Classification Under IND AS 109
A refundable security deposit is classified as a financial asset measured at amortised cost — specifically, a loan receivable (in the lessee's books) or a financial liability (in the lessor's books). This is because:
- The business model is "hold to collect" — the lessee expects to receive the deposit back at lease end
- The contractual cash flows are solely payments of principal and interest (SPPI test passes)
3. Initial Recognition — Fair Value & Day 1 Discount
At the commencement date, the security deposit is recognised at fair value, not at the amount paid. Fair value is calculated by discounting the future refund amount at the lessee's Incremental Borrowing Rate (IBR) or the prevailing market rate for a similar instrument.
Formula: Fair Value = Deposit Amount ÷ (1 + IBR)ⁿ where n = lease term in years
The difference between the cash paid and the fair value is the Day 1 Discount (also called the "Day 1 loss"). This discount represents the cost of giving an interest-free loan and is recognised as:
- Prepaid Rent / Deferred Rent Expense (if it relates to a lease) — this is then amortised over the lease term as rent expense
- Finance Cost / Other Expense — if not related to a lease arrangement
4. EIR Amortisation Schedule
After initial recognition at fair value, the security deposit is carried at amortised cost. Each period, you "unwind" the discount by recognising interest income (in the lessee's books) using the Effective Interest Rate (EIR), which equals the IBR used at initial recognition.
The amortised cost builds back up from fair value to the nominal deposit amount by the end of the lease — at which point the deposit is refunded at face value.
5. Journal Entries — Full Set
Note: At refund date, the security deposit carrying value = original nominal amount (fully unwound), so the journal entry is a clean debit to Bank and credit to Security Deposit for the face value.
6. Worked Example
Scenario: Lease commencement 1 April 2024 · Security deposit paid ₹6,00,000 · Lease term 3 years · IBR / EIR 10% p.a. · Deposit is refundable in full at lease end · No interest paid by lessor
Step 1: Calculate Fair Value of Deposit
Fair Value = ₹6,00,000 ÷ (1 + 0.10)³ = ₹6,00,000 ÷ 1.331 = ₹4,50,789
Step 2: Calculate Day 1 Discount
Day 1 Discount = ₹6,00,000 − ₹4,50,789 = ₹1,49,211
This ₹1,49,211 is recognised as Prepaid Rent at commencement and expensed equally over 3 years (₹49,737 per year) as rent expense.
Step 3: EIR Amortisation Schedule
| Year | Opening Carrying Value | Interest Income (10%) | Closing Carrying Value |
|---|---|---|---|
| Year 1 (FY 2024-25) | ₹4,50,789 | ₹45,079 | ₹4,95,868 |
| Year 2 (FY 2025-26) | ₹4,95,868 | ₹49,587 | ₹5,45,455 |
| Year 3 (FY 2026-27) | ₹5,45,455 | ₹54,545 | ₹6,00,000 |
| Total Interest Income | ₹1,49,211 | ||
Check: Total interest income over 3 years (₹1,49,211) = Day 1 Discount (₹1,49,211). The maths always balances — the carrying value grows back to ₹6,00,000 by year-end, exactly when the deposit is refunded.
Step 4: Journal Entries for Year 1
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The lessor's accounting is the mirror image of the lessee's:
| Item | Lessee's Books | Lessor's Books |
|---|---|---|
| At commencement | Dr Security Deposit (FV) Dr Prepaid Rent (discount) Cr Bank | Dr Bank Cr Security Deposit Liability (FV) Cr Deferred Rent Income (discount) |
| Each period | Dr Security Deposit Cr Interest Income | Dr Finance Cost (P&L) Cr Security Deposit Liability |
| Prepaid/deferred | Dr Rent Expense Cr Prepaid Rent | Dr Deferred Rent Income Cr Rent Income (P&L) |
| At refund | Dr Bank Cr Security Deposit | Dr Security Deposit Liability Cr Bank |
8. Frequently Asked Questions
What rate do I use for discounting — IBR or market rate?
IND AS 109 requires that the discount rate reflects a market rate of interest for a similar instrument. For most lessees, the best practical proxy is the Incremental Borrowing Rate (IBR) — the rate at which the company could borrow a similar amount for a similar term. Use your most recent unsecured term loan rate or MCLR-linked rate as a starting point.
Can I use a flat rate or straight-line approach instead?
No. IND AS 109 mandates the EIR method for amortised cost measurement. You cannot use a flat rate or straight-line unwinding of the discount — it must follow the effective interest rate method, which produces a gradually increasing interest income charge (as seen in the schedule above).
What if the deposit is partially refundable?
Treat the refundable and non-refundable portions separately. The refundable portion is a financial asset (apply IND AS 109 — discount and unwind). The non-refundable portion is a prepaid expense under IND AS 116 / IAS 17 — amortise over the lease term.
How does IND AS 116 interact with IND AS 109 for the same lease?
They are separate accounting requirements. IND AS 116 deals with the lease liability and ROU asset (driven by lease rentals). IND AS 109 deals with the security deposit (a separate financial instrument). Both standards apply simultaneously to the same lease arrangement — the security deposit is excluded from the IND AS 116 lease liability calculation.
Is there a materiality threshold?
IND AS does not define a formal monetary threshold, but materiality is always a consideration. For very small deposits (e.g., ₹5,000–10,000 deposit for a minor service connection), most auditors and CFOs would consider the discounting adjustment immaterial and not worth the effort. For lease security deposits — which are typically 3–6 months of rent — the adjustment is almost always material and must be computed.