Accounting for Lease

This Standard is mandatory in nature. AS 19 prescribes the accounting and disclosure requirements for both finance leases and operating leases in the books of the lessor and lessee. The classification of leases adopted in this standard is based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor and the lessee.

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. An operating lease is a lease other than finance lease.

At the inception of the lease, assets under finance lease are capitalized in the books of lessee with corresponding liability for lease obligations as against the operating lease, wherein lease payments are recognized as an expense in profit and loss account on a systematic basis (i.e. straight line) over the lease term without capitalizing the asset. The lessor should recognise receivable at an amount equal to net investment in the lease in case of finance lease, whereas under operating lease, the lessor will present the leased asset under fixed assets in his balance sheet besides recognizing the lease income on a systematic basis (i.e. straight line) over the lease term. The person (lessor/lessee) presenting the leased asset in his balance sheet should also consider the additional requirements of AS 6 and AS 10.

AS 19 applies to contracts that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. Examples include the supply of property, vehicles and computers.

On the other hand, this Statement does not apply to agreements that are contracts for services that do not transfer the right to use assets from one contracting party to the other.

The definition of a lease includes agreements for the hire of an asset which contain a provision giving the hirer an option to acquire title to the asset upon the fulfillment of agreed conditions. These agreements are commonly known as hire purchase agreements.

Hire purchase agreements include agreements under which the property in the asset is to pass to the hirer on the payment of the last installment and the hirer has a right to terminate the agreement at any time before the property so passes.

Definition of the Terms used under AS 19

  • A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.
  • A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset.
  • An operating lease is a lease other than a finance lease.
  • A non-cancellable lease is a lease that is cancellable only:
    • Upon the occurrence of some remote contingency or
    • With the permission of the lessor or
    • If the lessee enters into a new lease for the same or an equivalent asset with the same lessor;
    • Upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably certain.
  • The inception of the lease is the earlier of the date of the lease agreement and the date of a commitment by the parties to the principal provisions of the lease.
  • The lease term is the non-cancellable period for which the lessee has agreed to take on lease the asset together with any further periods for which the lessee has the option to continue the lease of the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise.
  • Minimum lease payments are the payments over the lease term that the lessee is, or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with:
  • In the case of the lessee, any residual value guaranteed by or on behalf of the lessee or
  • In the case of the lessor, any residual value guaranteed to the lessor:
    • By or on behalf of the lessee or
    • By an independent third party financially capable of meeting this guarantee.

However, if the lessee has an option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable that, at the inception of the lease, is reasonably certain to be exercised, the minimum lease payments comprise minimum payments payable over the lease term and the payment required to exercise this purchase option.

Mr. X took mine on lease from Mr. Y on the terms that he would pay ` 10,000 or ` 10 per ton extracted during the year, which ever is less. ` 10 per ton been contingent cannot be included in minimum lease payment calculation.

  • Economic life is either:
    • The period over which an asset is expected to be economically usable by one or more users;
    • The number of production or similar units expected to be obtained from the asset by one or more users.
  • Useful life of a leased asset is either:
    • The period over which the leased asset is expected to be used by the lessee or
    • The number of production or similar units expected to be obtained from the use of the asset by the lessee.
  • Residual value of a leased asset is the estimated fair value of the asset at the end of the lease term.
  • Guaranteed residual value is:
    • In the case of the lessee, that part of the residual value which is guaranteed by the lessee or by a party on behalf of the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable) and
  • In the case of the lessor, that part of the residual value which is guaranteed by or on behalf of the lessee, or by an independent third party who is financially capable of discharging the obligations under the guarantee.
  • Unguaranteed residual value of a leased asset is the amount by which the residual value of the asset exceeds its guaranteed residual value.

We can say that:

Residual Value of the Assets = Guaranteed Residual Value + Unguaranteed Residual Value

  • Gross investment in the lease is the aggregate of the minimum lease payments under a finance lease from the standpoint of the lessor and any unguaranteed residual value accruing to the lessor.
  • Unearned finance income is the difference between:
  • The gross investment in the lease and
  • The present value of
    • The minimum lease payments under a finance lease from the standpoint of the lessor and
    • Any unguaranteed residual value accruing to the lessor, at the interest rate implicit in the lease.
  • Net investment in the lease is the gross investment in the lease less unearned finance income.
  • The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of
    • The minimum lease payments under a finance lease from the standpoint of the lessor and
    • Any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased asset.
  • The lessee’s incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset.
  • Contingent rent is that portion of the lease payments that is not fixed in amount but is based on a factor other than just the passage of time (e.g., percentage of sales, amount of usage, price indices and market rates of interest).

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