ACCOUNTING STANDARD-19 LEASES

Sowmya G S
2nd M.COM

OBJECTIVES

Prescribe appropriate accounting policies & disclosures for lessees & lessors in relation to:

Finance Lease Operating

Lease

APPLICABILITY

Applies to leases commencing on and from 1st April 2001.

Excludes

Lease agreements to explore for or use natural resources (oil, gas, timber, metals & other mineral rights) Licensing agreements for such items as video recordings, plays, manuscripts, patents & copyrights.
Lease agreements to use lands.

DEFINITIONS
A lease is an agreement by which the lessor gives the right to use an asset for given period of time to the lessee on rent. 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.

Contd
Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arms length transaction. Residual value of a leased asset is the estimated fair value of the asset at the end of the lease term.

ConTD.
Economic life is either: a) The period over which an asset is expected to be economically usable by one or more users; or b) The number of production or similar units expected to be obtained from the asset by one or more users.

ConTD.
Minimum Lease Payment For lessor = Total lease rent to be paid by lessee over the lease term + any guaranteed residual value contingent rent cost for service and tax to be paid by and reimbursed to lessor + residual value guaranteed by third party. For lessee = Total lease rent to be paid by lessee over the lease terms + any guaranteed residual value (for lessor)

ConTD.
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., amount of usage, market rate of interest) Unguaranteed Residual Value is the difference between residual value of asset and its guaranteed residual value

CLASSIFICATION OF LEASES

A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. Title may or may not eventually be transferred.
An operating lease is a lease other than a finance lease

Classification depends on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor or the lessee.

EXAMPLES OF FINANCE LEASE

Ownership transferred by end of lease term. Lease contains bargain purchase option. Lease term for major part of assets economic life. Present value of minimum lease payments amounts to at least substantial all of assets fair value of the leased asset. Leased asset is of specialized nature that only lessee can use without major modifications being made.

INDICATORS FOR FINANCE LEASES

Lessors losses associated with cancellation (if lessee can cancel lease) borne by lessee. Gains or losses from fluctuation in fair value of residual fall on lessee. Lessee can continue lease for a secondary period at a rent substantially lower than market rent.

Operating Lease vs. Finance Lease

Operating lease Finance lease

Lessor is the legal and the economic owner

Lessor is the legal owner Lessee is the economic owner

Risks and rewards associated with the asset not substantially transferred

Risks and rewards associated with the asset are substantially transferred

Risks include losses due to idle capacity, technological obsolescence & changing economic

conditions. Rewards include expectation of profitable operation over economic life of asset and
gain from appreciation in value or realisation of residual value

Source: Accounting Standard 19 issued by the Institute of Chartered Accountants of India

ACCOUNTING TREATMENT

ACCOUNTING FOR FINANCE LEASE LESSEES BooKS

At inception of a finance lease, lessee should recognize lease as an asset and a liability on the basis of fair value or present value of minimum lease payments . Liability for a leased asset should be presented separately in balance sheet as a current liability or a long-term liability as case may be. Lease payments should be apportioned between finance charge and reduction of outstanding liability on a basis which produces a constant periodic rate of interest on remaining balance of liability for each period.

ConTD.
A finance lease gives rise

to depreciation expense for asset (on the basis of lessees depreciation policy for owned assets) as well as a finance expense for each accounting period. If there is no reasonable certainty that lessee will obtain ownership by end of lease term, asset should be fully depreciated over lease term or its useful life whichever is shorter.

ACCOUNTING FOR FINANCE LEASES LESSoRS BooKS

Lessor should recognize assets given under

a finance lease in its balance sheet as a receivable at an amount equal to net investment in the lease. un guaranteed residual value-unearned finance income).

(MLP+

ConTD.
Recognition of finance income should reflect a constant periodic rate of return on net investment of lessor outstanding in respect of finance lease. Manufacturer or dealer lessor should recognize transaction of sale in profit and loss statement for the period, in accordance with policy followed by enterprise for outright sales. In case of artificially low rate of interest, compute sale price based on commercial rates of interest. Initial direct costs to be recognized as an expense in the statement of profit and loss at the inception of the lease.

ACCOUNTING FOR OPERATING LEASE LESSEES BooKS Lease payments (excluding costs for services such as insurance & maintenance) under operating lease should be recognised as an expense in profit and loss on a straight line basis over lease term unless another systematic basis is more representative of time pattern of users benefit.

ACCOUNTING FOR OPERATING LEASE LESSoRS BooKS

Lease income from operating leases should be recognised in profit and loss on a straight line basis over lease term unless another systematic basis more representative of time pattern in which benefit derived from use of leased asset diminished.
Leased asset to be disclosed under fixed assets. Depreciation of leased assets should be on a basis consistent with normal depreciation policy of lessor for similar assets.

DISCLOSURES FOR FINANCE LEASE

Lessee
(a) (b) (c) (d)

Lessor
(a) (b)

(e)

(f)
(g)

Leased assets segregated Net carrying amount Reconciliation between total minimum lease payments & present value Total minimum lease payments & present value under three periodic bands (<1) (>1-5) & (.5 years) Contingents rents Future minimum sublease payments expected to be received Significant lease arrangements.

(c) (d) (e)

(f)
(g) (h)

Reconciliation between total gross investment & present value of MLP Total gross investments & present value of MLP under three periodic bands (<1) (>1-5) & (>5 years) Contingent rents Significant leasing arrangements Unearned finance income Un-guaranteed residual value accruing to lessor Accumulated provision for uncollectible MLP receivable Accounting policy of initial direct costs.

DISCLOSURES FOR OPERATING LEASE

Lessee
(a)
(b)

Lessor
(a)
(b) (c) (d)

(c) (d) (e)

Total future MLP under three periodic bands (<1) (>1-5) & (>5 years) under non cancellable operating leases. Total future minimum sublease payments under non cancellable sublease. Lease payments in P&L separately for MLP & contingent rents Sublease payments in P&L. Significant leasing arrangements (contingent rents determination, renewal or purchase & escalation terms and restrictions dividend additional debt and sub-leasing).

(e)

Total future MLP under three periodic bands (<1) (>1-5) & (>5 years) Contingent rents. Significant leasing arrangements. Gross carrying amount accumulated depreciation & impairment for each class of assets & depreciation and impairment losses recognised/reversed in P&L. Accounting policy of initial direct costs.

Problem
Lease Term : 5 years Useful life of Equipment : 8 years F M V : Rs.10000 Lease rentals : Rs.3000 payable at end of each of the 5years Insurance : Rs.500 to be paid annually by the lessee to the lessor Residual value estimated at the end of 5th year : Rs.1000 Lessee guaranteed residual value to lessor : Rs.2000 Lessees incremental borrowing rate : 20% (lessors IRR not known) Advise accounting in the books of lessee

Thank You