Dry Lease: The Deal Behind Every IndiGo Flight You’ve Ever Taken

Here’s something most frequent flyers don’t think about: the aircraft that just flew you from Mumbai to Delhi probably isn’t owned by the airline that sold you the ticket. It’s leased. And not leased in the vague “we rent it” sense leased under a very specific contractual arrangement called a dry lease that has enormous consequences for how airlines look on paper, how analysts should read their financial statements, and why the balance sheets of carriers like IndiGo look so dramatically different today than they did five years ago.

This isn’t just aviation trivia. The accounting treatment of dry leases changed under IFRS 16 in 2019, and that change is one of the more instructive case studies in the entire FSA curriculum for understanding what happens when a major off-balance-sheet obligation suddenly gets forced onto the balance sheet. Airlines were the poster child for this transition, and understanding the mechanics is genuinely useful for any analyst who works with capital-intensive, lease-heavy businesses which, as it turns out, includes a lot of them.

Dry vs. Wet: The Distinction That Actually Matters

When an airline leases an aircraft, the first question is whether the deal includes the people and services that go with it or just the metal itself.

A wet lease bundles in the crew, maintenance, and insurance alongside the aircraft. The acronym you’ll see in the industry is ACMI Aircraft, Crew, Maintenance, Insurance. The lessee airline is essentially renting a fully staffed, maintained, insured aircraft and paying by the hour or cycle. The aircraft continues to operate under the lessor’s air operator certificate, not the lessee’s. These arrangements tend to be short-term, used to plug gaps a carrier might wet lease aircraft during peak season, or to cover for planes grounded for heavy maintenance.

A dry lease is the opposite end of the spectrum. The lessee gets the aircraft and nothing else. No crew, no maintenance contract, no insurance. The airline takes full operational responsibility its own pilots fly it, its own maintenance organisation (or a contracted MRO) keeps it airworthy, its own insurance team arranges hull and liability coverage. The aircraft operates under the lessee’s own air operator certificate, which is why from a regulatory and operational standpoint it’s indistinguishable from an owned aircraft.

The overwhelming majority of long-term commercial aircraft leasing is done on a dry basis. When AerCap which after acquiring GE Capital Aviation Services became the world’s largest aircraft lessor, with a fleet worth tens of billions of dollars places an Airbus A320 with IndiGo for twelve years, that’s a dry lease. IndiGo pays a monthly rental, operates the aircraft however it chooses within the maintenance agreements, and at the end of the lease returns the aircraft in the agreed condition. AerCap retains ownership of the physical asset and takes it back at lease end.

Why Airlines Lease Rather Than Own

Before getting into accounting, it’s worth spending a moment on why this business model exists at all, because it’s not immediately obvious why a company would prefer paying rent indefinitely over building equity in a physical asset.

The answer, for most airlines, comes down to capital allocation and flexibility. A new Airbus A320neo costs somewhere in the range of $110–130 million at list price (actual transaction prices are considerably lower after discounts, but still tens of millions of dollars). An airline operating two hundred aircraft would need to deploy tens of billions of dollars in capital just to own its fleet outright capital that would be sitting in depreciating assets rather than available for route expansion, marketing, loyalty programmes, or simply surviving the next demand shock.

Leasing converts that capital requirement into a series of predictable monthly payments, frees up capital for other uses, and crucially shifts the residual value risk of the aircraft onto the lessor. When a twelve-year-old aircraft reaches end of lease and the market for used narrowbodies happens to be weak, that’s AerCap’s problem, not IndiGo’s. The airline just hands back the keys and decides whether to extend, return, or negotiate for a replacement.

For lessors, the model works because they can diversify residual value risk across hundreds of aircraft and dozens of lessees globally, and because aircraft, particularly popular narrowbody types like the A320 family and Boeing 737 have remarkably liquid secondary markets. A lessor that loses an airline customer can typically remarket the aircraft to another carrier within a reasonable period.

The Accounting Revolution: What IFRS 16 Actually Changed

Now for the part that lives squarely in the FSA curriculum.

Under the old lease accounting standard IAS 17 under IFRS, ASC 840 under US GAAP the classification of a lease as “operating” or “finance” determined almost everything about how it appeared in the financial statements. Finance leases (those that substantially transferred the risks and rewards of ownership) were on-balance-sheet, looking essentially like a financed purchase. Operating leases were off-balance-sheet: the monthly rental payment hit the income statement as an operating expense, and nothing appeared on the balance sheet at all.

Most dry aircraft leases, being for defined terms shorter than the aircraft’s economic life and with no transfer of ownership, were classified as operating leases. Which meant that an airline like IndiGo, with hundreds of aircraft generating billions of dollars in annual lease obligations, showed essentially none of that obligation on its balance sheet. The planes existed. The monthly obligations existed. The future minimum lease payments existed, disclosed in the notes but buried there you had to dig them out and capitalise them yourself if you wanted a complete picture of the airline’s financial leverage.

Analysts did exactly that, and the adjustment was often dramatic. An airline that looked moderately leveraged on reported figures could look very highly leveraged once someone ran the standard operating lease capitalisation taking the annual lease expense, applying a multiple or discounting the future minimum payments, and adding the result to both assets and debt. But the adjustment was manual, inconsistent across analysts, and not always visible in headline numbers.

IFRS 16, effective for periods beginning on or after January 2019, ended that era. Under the new standard, virtually every lease with a term exceeding twelve months with narrow exceptions for low-value assets must be recognised on the balance sheet. The lessee records a right-of-use asset representing the right to use the leased asset over the lease term, and a lease liability representing the present value of future lease payments. Both hit the balance sheet on day one of the lease, regardless of whether the arrangement would have previously been considered operating or finance.

For Indian airlines reporting under Ind AS (which largely converges with IFRS), this transition was significant. IndiGo’s transition to Ind AS 116 (the Indian equivalent of IFRS 16) resulted in substantial additions to both the asset and liability sides of its balance sheet as the entire fleet of leased aircraft was recognised simultaneously. Reported debt ratios moved materially not because anything changed about the company’s actual financial obligations, but because obligations that had been off-balance-sheet were now on it.

What the Income Statement Looks Like Under the New Standard

Here’s where things get a little counterintuitive, and where the FSA implications are most concentrated.

Under the old operating lease treatment, the monthly lease rental hit the income statement as a single operating expense. It sat above EBIT and above EBITDA. Airlines often had enormous lease expense lines for some carriers; it was the largest single line item after fuel and staff costs and that expense was fully reflected in EBITDA.

Under IFRS 16, the single lease expense disappears. Instead, the income statement shows two new items: depreciation on the right-of-use asset, and interest on the lease liability. Depreciation sits above EBIT but gets added back when calculating EBITDA (by definition). Interest sits below EBIT and is excluded from EBITDA. The net effect is that EBITDA mechanically increases sometimes very significantly when a company transitions from IAS 17 to IFRS 16, even though nothing about the cash flows changed.

This is not an improvement in the company’s operating performance. It’s an accounting reclassification. An analyst comparing an airline’s EV/EBITDA multiple pre-2019 to its multiple post-2019 using reported EBITDA is not making an apples-to-apples comparison, and that comparison can produce badly wrong conclusions if the reclassification isn’t adjusted for.

The industry response to this problem is EBITDAR earnings before interest, taxes, depreciation, amortisation, and rent (or lease payments). EBITDAR strips out both the old lease expense and the new depreciation/interest to arrive at a pre-lease operating earnings figure that is comparable across accounting regimes and across companies with different lease versus own mixes. It’s not a perfect metric, but it’s a more stable basis for comparison than EBITDA in industries where lease-versus-own choices vary significantly.

A Worked Example: One A320neo, Full Treatment

Let’s make this concrete with a single aircraft.

Suppose a carrier enters a dry lease for a new Airbus A320neo. Monthly rental is ₹2.5 crore, giving annual payments of ₹30 crore. The lease term is ten years. Using the airline’s incremental borrowing rate of 7%, the present value of ten years of ₹30 crore annual payments is approximately ₹210 crore.

On the day the lease commences, the airline records a right-of-use asset of ₹210 crore and a lease liability of ₹210 crore. Total assets go up ₹210 crore, total liabilities go up ₹210 crore. Net worth doesn’t change, but debt ratios deteriorate.

In year one, the income statement shows depreciation of approximately ₹21 crore (₹210 crore divided by ten years, straight-line), and interest of approximately ₹14.7 crore (7% on the opening lease liability of ₹210 crore). Total income statement impact: ₹35.7 crore, compared to ₹30 crore under the old operating lease treatment. The front-loading of interest means year-one charges are higher than the cash payment; this reverses in later years as the liability amortises.

By year ten, the right-of-use asset is fully depreciated to zero, the lease liability is fully extinguished, and the aircraft goes back to the lessor. The accounting and the economics have converged.

What the COVID Years Showed Us About Dry Lease Risk

The pandemic offered an involuntary stress test of the dry lease model that no business school case study could have designed.

Airlines globally saw revenue evaporate almost overnight in March 2020. Fleets were grounded. In some weeks, aircraft utilisation dropped to near zero. But the lease obligations kept running monthly rentals were contractually fixed, payable regardless of whether the aircraft was flying revenue-generating routes or sitting on the tarmac.

The scale of these obligations, now visible on airline balance sheets under IFRS 16, made the cash flow problem starkly apparent. Carriers couldn’t simply pause their largest fixed costs. Many airlines including several Indian ones had to approach their aircraft lessors to negotiate payment deferrals, stretching near-term rental payments into later periods. Lessors, for the most part, cooperated: repossessing hundreds of aircraft simultaneously and attempting to remarket them into a market where every airline was also cutting capacity was not an attractive alternative. But the episode made clear that the right-of-use asset and lease liability on the balance sheet represent real, contractually binding obligations, not accounting abstractions.

The Broader Lesson Beyond Aviation

One reason the dry lease / IFRS 16 discussion belongs in the FSA curriculum is that it illustrates a principle that extends far beyond aviation: many industries rely heavily on leased assets, and the analysts who understand what’s really in those balance sheets have a genuine advantage over those who take reported figures at face value.

Retailers with large store portfolios, logistics companies with leased warehouse and truck fleets, shipping companies with chartered vessels, hotel groups that manage rather than own properties all of these have substantial lease commitments that IFRS 16 now requires to be visible on the balance sheet. For each of them, the same analytical framework applies: understand the ROU asset and lease liability, assess the leverage on a lease-inclusive basis, use rent-adjusted metrics for cross-company comparisons, and don’t mistake a post-IFRS 16 EBITDA improvement for an improvement in underlying economics.

Exam Perspective: What to Lock In

A few points worth carrying clearly into any FSA exam context. A dry lease provides the aircraft without crew, maintenance, or insurance the lessee takes full operational responsibility. Under IFRS 16 (and Ind AS 116 for Indian reporters), dry leases with terms over twelve months require recognition of a right-of-use asset and lease liability at the present value of future payments, discounted at the implicit rate or the lessee’s incremental borrowing rate. The income statement shows depreciation and interest rather than a single lease expense, which mechanically increases EBITDA relative to the old treatment without any change in economic performance. EBITDAR is the appropriate metric for cross-company comparison in lease-heavy industries. The transition from IAS 17 to IFRS 16 inflated reported leverage ratios for airlines without any genuine change in financial risk analysts comparing across periods or across companies with different transition dates need to adjust. And residual value risk the uncertainty about what a used aircraft is worth at end of lease sits with the lessor under a dry lease, not the lessee, which is part of why airlines prefer leasing over ownership in the first place.

Final Thoughts

The dry lease is, at its core, a sensible response to a capital allocation problem: airlines need aircraft to operate, but tying up enormous amounts of capital in depreciating physical assets isn’t the best use of money for businesses where margins are thin, demand is cyclical, and flexibility matters enormously. The lessor community that grew up to serve this need AerCap, Air Lease, SMBC Aviation Capital, and dozens of others has become a structurally important part of the global aviation system, sitting quietly between the aircraft manufacturers and the airlines the travelling public actually sees.

What IFRS 16 did was make the financial consequences of that arrangement visible in a way they hadn’t been before. Whether that visibility is a feature or a bug depends partly on your perspective airlines would often prefer the old off-balance-sheet treatment, while investors and creditors generally benefit from seeing the full picture. From an analyst’s standpoint, the obligation was always real. The accounting has simply caught up.