Accounting standard 19:-accounting for leases

Upasana Sethm.com(3rd

semester)8866

Points of discussions

1) • Applicability, scope & objectives of AS 19

2)• Definitions & lease terms

3)• Classifications of lease

4)

• Accounting for lease & its disclosure requirements

5)• Sale & lease back transactions

APPLICABILITY

EFFECTIVE IN RESPECT OF ALL ASSETS LEASED ON OR AFTER 1ST APRIL, 2001

MANDATORY IN NATURE

PRESCRIBES APPROPRIATE ACCOUNTING POLICIES & DISCLOSURES TO LESSOR AND LESSEE IN RELATION TO FINANCE & OPERATING LEASE.

EXCLUSIONS

Lease agreements to explore for or use natural resources , such as oil, gas, timber, metals and other mineral rights.

Licensing agreements for items such as motion picture films ,video recordings, plays, manuscripts, patents and copyrights.

Lease agreements to use lands.

Definition of lease

A lease is an agreement whereby the lesser 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.

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

” The concept of Lease is influenced by this quote. We can compare ‘milk’ with the ‘rights to use an asset’ and ‘cow’ with the ‘asset’ itself. Ultimately, a person who wants to manufacture a product using machinery can get to use that machinery under a leasing arrangement without owning it.

A famous quote by Donald B. Grant

says, “Why own a cow when the milk is so cheap? All you really need is milk and not the cow”.

The period over which the asset is expected to be economically usable by one or more users

The number of production or similar units expected from the asset by one or more users.

EITHER

OR

Economic life of an asset

The period over which the leased asset is expected to be used by the lessee.

The number of production or similar units expected to be obtained from the asset by the lessee.

Useful life of a leased asset

Guaranteed residual value

Sometimes lessee agrees to make up any deficiency below a stated amount that the lesser realizes in the residual value at the end of the lease term. In such a case , that stated amount is the guaranteed residual value.

Unguaranteed residual value

The difference between residual value of asset and its guaranteed residual value is unguaranteed residual value.

Minimum lease payments(MLP)

Minimum lease payments are the payments that are expected to be made over the life of the lease, including:-

Minimum periodic payments required by the lease over the lease term

Payment required by a bargain purchase option

Any guaranteed residual value

Any payment resulting from the failure to renew or extend the lease

When the lesser gives an asset on lease( particularly on finance lease), the total amount which he receives over lease period by giving the asset on lease, includes the element of interest plus payment of principal amount of asset. The rate at which the interest amount is calculated can be simply called implicit rate of interest. In other words, it is implied interest rate at which the lease transaction is done. More accurately it can be expressed as under:-

It is the discount rate at whichFair value of the asset( at the inception of lease)

present value of minimum lease payment + any unguaranteed residual value accruing to the lesser

Interest rate implicit in the lease

Classification of

leases

• Lease that transfers substantially the risk and rewards incident to the ownership of an asset.

Finance lease

• An operating lease is a contract that allows for the use of an asset, but does not convey rights of ownership of the asset. An operating lease represents an off-balance sheet financing of assets, where a leased asset and associated liabilities of future rent payments are not included on the balance sheet of a company.

Operating or service

lease

Accounting for finance lease( books of lessee)

The discount rate is the interest rate implicit on the lease is his is practicable to determine, if not, the lessee’s incremental borrowing

rate should be used

The amount is equal to fair value of the leased asset or present value of the MLP from lessee’s view point, whichever is lower.

At the inception, lessee recognises the lease as an asset and liability

Each lease payment is apportioned between finance charge & principal amount .PRINCIPAL amount is reduced from the outstanding liability. Finance cost is allocated over the lease term in such a manner that it would produce a constant rate of return on the remaining principal balance

Finance lease gives rise to a depreciation, it should be calculated in accordance with AS6.

Indirect initial cost incurred specifically for the lease should be included in the amount

recognised as an asset under the lease.

Disclosure infinance lease by lessee

The total of MLP’s and their PV’s at the balance sheet date for each of the following periods should be disclosed: -

1) not later than 1 year

2) later than 1 year and not later than 5 years

3) later than 5 years

A reconciliation of total MLP with its present value on balance sheet date.

Contingent rent recognised as an expenses in the statement of profit and loss for the period.

Assets acquired under finance lease to be segregated from the assets owned.

Net carrying amount at the balance sheet date of each class of assets.

Accounting for finance lease – in the books of lesser

Recognises the assets given as a receivables at an amount equal to net investment in the lease

NI= PV(MLP)+ PV(URV), DISCOUNTING FACTOR IS THE INTEREST RATE IMPLICIT ON THE LEASE

In case there is no URV is expected to accrue to the lesser , the amount of lease receivables recorded by the lesser and the amount of lease liability recorded by the lessee are same.

Any direct cost incurred at the inception of the lease may either be recognised immediately or allocated against the finance income over the lease term.

DISCLOSURE IN FINANCE LEASEBY THE LESSER:-

General description of the significant lease arrangement

Accounting policy for initial direct cost.

Reconciliation of total gross investment in lease and present value of MLP receivable at balance sheet date.

Minimum lease payment(MLP) receivables in following categories Not later than one year Later than one year and not later than five years. Later than five years.

ACCOUNTING FOR OPERATING LEASE –IN THE BOOKS OF LESSEE

Lease should be recognised as a expense in the statement of Profit& loss on straight line method basis. If any other method is more representative of the time pattern of the user’s benefit such method can be used.

DISCLOSURE IN OPERATING LEASE BY THE LESSEE:-

General description of the significant lease arrangement.Total of future minimum lease payments in following period:

Not later than one year Later than one year and not later than five years.

Later than five years.

Lease payments recognized in profit/loss account for the period.

Accounting for operating lease:-in the books of lesser

DISCLOSURE IN OPERATING LEASE BY THE LESSER-

SALE AND LEASE BACKHere the owner of an asset sells the asset to a party (the buyer) , who in turn leases back the

same asset to the owner in consideration of lease rentals.

However, under this arrangement , the assets are not physically exchanged but it all happens in

record only.

Sale and lease back transaction is suitable for those assets, which are not subject to

depreciation but appreciation, say land.

ACCOUNTING TREATMENT FOR SALE AND LEASE BACK:- IF LEASE BACK IS A FINANCIAL LEASE

Any profit or loss of sale proceeds over the carrying amount(book value) should not be immediately

recognized as profit or loss in the financial statements of a seller-lessee.

It should be deferred and amortised over the lease term in proportion to the depreciation of leased asset.

ACCOUNTING TREATMENT FOR SALE AND LEASE BACK:- IF LEASE BACK IS A OPERATING LEASE

CASE 1If sale price below fair value

1) PROFIT i.e. carrying amount is less than sale value , recognise profit immediately.

2) LOSS i.e. carrying amount is more than sale value, recognises loss immediately, provided loss is not

compensated by future lease payment.3) LOSS i.e. carrying amount is more than sale price,

defer and amortize loss if loss is compensated by future lease payment.

CASE 2

CASE 3 If sale price ABOVE fair value

1)If carrying equal to fair value which will result in profit, amortise the profit over lease period.

2)Carrying amount less than fair value will result in profit- amortize and defer the profit equal to sale price less fair value and recognise balance

profit immediately.3)Carrying amount is more than fair value-which

will result in loss equal to-(carrying amount less than fair value)