Accounting Standard (AS) 19:- LEASE T. Y. B. COM (HONS) Presented by – Shree Vardhan Poddar :- 63 Nikhar Bansal :- 27 Disha Kochher :- 16 Sakshar Sindhwani :- 40 Index • Summary • Objective ,scope and definations • Classification of leases • Leases in the financial statements of lessees • Indian and international accounting standards compared: • Hire purchase versus lease Summary
AS 19 prescribes the accounting and disclosure requirement for both finance leases and operating leases in the books of the lesser and lessee . The classifications of leases adopted in this standards is based on the extents to which risks and rewards incident to ownership of a leased asset lie with the lesser 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. t the inception of the lease, assets under finance 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 over the lease term without capitalizing the asset. The lesser should recognize receivable at an amount equal to net investment in the lease in case of finance lease, whereas under operating lease/the lesser will present the leased asset under fixed assets in his balance sheet besides recognizing the lease income on a systematic basis over the lease term .
Objective The objective of this Standard is to prescribe, for lessees and lesser, the appropriate accounting policies and disclosures in relation to finance leases and operating leases. Scope 1. This Standard should be applied in accounting for all leases other than: (a) lease agreements to explore for or use natural resources, such as oil, gas, timber, metals and other mineral lights; and (b) licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights; and (c) lease agreements to use lands. 2.
This Standard applies to agreements 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. On the other hand, this Standard 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. Definitions Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series of contractual, periodic, tax deductible payments.
The lessee is the receiver of the services or the assets under the lease contract and the lessor is the owner of the assets. The relationship between the tenant and the landlord it’s called a tenancy, and can be for a fixed or an indefinite period of time (called the term of the lease). The consideration for the lease is called rent. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from lawnmowers.
Under normal circumstances, an owner of property is at liberty to do what they want with their property, including destroys it or hand over possession of the property to a tenant. However, if the owner has surrendered possession to another (i. e. the tenant) then any interference with the quiet enjoyment of the property by the tenant in lawful possession is unlawful The following terms are used in this Standard with the meanings specified: 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.
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. An operating lease is a lease other than a finance lease. A non-cancelable lease is a lease that is cancelable only: (a) Upon the occurrence of some remote contingency; (b) With the permission of the lesser; (c) If the lessee enters into a new lease for the same or an equivalent asset with the same lesser; or (d) Upon payment by the lessee of such an dditional amount that, at inception of the lease, 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 commitment by the parties to the principal provisions of the lease. As at this date: (a) A lease is classified as either an operating or a finance lease; and (b) In the case of a finance lease, the amounts to be recognized at the commencement of the lease term are determined. The commencement of the lease term is the date from which the lessee is entitled to exercise its right to use the leased asset.
It is the date of initial recognition of the lease (ie the recognition of the assets, liabilities, income or expenses resulting from the lease, as appropriate). The lease term is the non-cancelable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the option.
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 lesser, together with: (a) For a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or (b) For a lesser, any residual value guaranteed to the lesser by: (i) The lessee; (ii) A party related to the lessee; or (iii) A third party unrelated to the lesser that is financially capable of discharging the obligations under the guarantee.
However, if the lessee has an option to purchase the asset at a price that is expected to be sufficiently lower than fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised, the minimum lease payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and the payment required to exercise it. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
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. Useful life is the estimated remaining period, from the commencement of the lease term, without limitation by the lease term, over which the economic benefits embodied in the asset are expected to be consumed by the entity. Guaranteed residual value is: a) for a lessee, that part of the residual value that is guaranteed by the lessee or by a party related to the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable);and (b) For a lesser, that part of the residual value that is guaranteed by the lessee or by a third party unrelated to the lesser that is financially capable of discharging the obligations under the guarantee. Unguaranteed residual value is that portion of the residual value of the leased asset, the realisation of which by the lessor is not assured or is guaranteed solely by a party related to the lessor.
Initial direct costs are incremental costs that are directly attributable to negotiating and arranging a lease, except for such costs incurred by manufacturer or dealer lessors. Gross investment in the lease is the aggregate of: (a) the minimum lease payments receivable by the lessor under a finance lease, and (b) any unguaranteed residual value accruing to the lessor. Net investment in the lease is the gross investment in the lease discounted at the interest rate implicit in the lease. Unearned finance income is the difference between: (a) the gross investment in the lease, and (b) the net investment in the lease.
The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of (a) the minimum lease payments and (b) the unguaranteed residual value to be equal to the sum of (i) the fair value of the leased asset and (ii) any initial direct costs of the lessor. 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 the future amount of a factor that changes other than with the passage of time (eg percentage of future sales, amount of future use, future price indices, future market rates of interest). The definition of a lease includes contracts for the hire of an asset that contain a provision giving the hirer an option to acquire title to the asset upon the fulfilment of agreed conditions. These contracts are sometimes known as hire purchase contracts. Classification of leases
The classification of leases adopted in this Standard is based on the extent to which risks and rewards incidental to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return because of changing economic conditions. Rewards may be represented by the expectation of profitable operation over the asset’s economic life and of gain from appreciation in value or realisation of a residual value. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership.
A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership. Because the transaction between a lessor and a lessee is based on a lease agreement between them, it is appropriate to use consistent definitions. The application of these definitions to the differing circumstances of the lessor and lessee may result in the same lease being classified differently by them. For example, this may be the case if the lessor benefits from a residual value guarantee provided by a party unrelated to the lessee.
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. * Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are: (a) the lease transfers ownership of the asset to the lessee by the end of the lease term; (b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised; c) the lease term is for the major part of the economic life of the asset even if title is not transferred; (d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and (e) the leased assets are of such a specialised nature that only the lessee can use them without major modifications. 11 Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are: a) If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee; (b) Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and (c) The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.
If it is clear from other features that the lease does not transfer substantially all risks and rewards incidental to ownership, the lease is classified as an operating lease. For example, this may be the case if ownership of the asset transfers at the end of the lease for a variable payment equal to its then fair value, or if there are contingent rents, as a result of which the lessee does not have substantially all such risks and rewards.
Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree to change the provisions of the lease, other than by renewing the lease, in a manner that would have resulted in a different classification of the lease if the changed terms had been in effect at the inception of the lease, the revised agreement is regarded as a new agreement over its term.
However, changes in estimates (for example, changes in estimates of the economic life or of the residual value of the leased property), or changes in circumstances (for example, default by the lessee), do not give rise to a new classification of a lease for accounting purposes. When a lease includes both land and buildings elements, an entity assesses the Classification of each element as a finance or an operating lease separately.
In determining whether the land element is an operating or a finance lease, an important consideration is that land normally has an indefinite economic life. Whenever necessary in order to classify and account for a lease of land and Buildings, the minimum lease payments (including any lump-sum upfront payments) are allocated between the land and the buildings elements in proportion to the relative fair values of the leasehold interests in the land element and buildings element of the lease at the inception of the lease.
If the lease payments cannot be allocated reliably between these two elements, the entire lease is classified as a finance lease, unless it is clear that both elements are operating leases, in which case the entire lease is classified as an operating lease. Separate measurement of the land and buildings elements is not required when the lessee’s interest in both land and buildings is classified as an investment property in accordance with AS 37 Investment Property and the fair value model is adopted. Detailed calculations are required for this assessment only if the classification of one or both elements is otherwise uncertain.
In accordance with AS 37 Investment Property, it is possible for a lessee to classify a property interest held under an operating lease as an investment property. If it does, the property interest is accounted for as if it was a finance lease and, in addition, the fair value model is used for the asset recognised. The lessee shall continue to account for the lease as a finance lease, even if a subsequent event changes the nature of the lessee’s property interest so that it is no longer classified as investment property.
This will be the case if, for example, the lessee: (a) Occupies the property, which is then transferred to owner-occupied property at a deemed cost equal to its fair value at the date of change in use; or (b) Grants a sublease that transfers substantially the entire risks and rewards incidental to ownership of the interest to an unrelated third party. Such a sublease is accounted for by the lessee as a finance lease to the third party, although it may be accounted for as an operating lease by the third party. Leases in the financial statements of lessees Finance leases
At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease. The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee’s incremental borrowing rate shall be used. Any initial direct costs of the lessee are added to the amount recognized as an asset.
Transactions and other events are accounted for and presented in accordance with their substance and financial reality and not merely with legal form. Although the legal form of a lease agreement is that the lessee may acquire no legal title to the leased asset, in the case of finance leases the substance and financial reality are that the lessee acquires the economic benefits of the use of the leased asset for the major part of its economic life in return for entering into an obligation to pay for that right an amount approximating, at the inception of the lease, the fair value of the asset and the related finance charge.
If such lease transactions are not reflected in the lessee’s balance sheet, the economic resources and the level of obligations of an entity are understated, thereby distorting financial ratios. Therefore, it is appropriate for a finance lease to be recognized in the lessee’s balance sheet both as an asset and as an obligation to pay future lease payments. At the commencement of the lease term, the asset and the liability for the future lease payments are recognised in the balance sheet at the same amounts except for any initial direct costs of the lessee that are added to the amount recognised as an asset.
Disclosures (a) For each class of asset, the net carrying amount at the end of the reporting period. (b) a reconciliation between the total of future minimum lease payments at the end of the reporting period, and their present value. In addition, an entity shall disclose the total of future minimum lease payments at the end of the reporting period, and their present value, for each of the following periods: (i) not later than one year; (ii) later than one year and not later than five years; (iii) later than five years. (c) contingent rents recognised as an expense in the period. d) the total of future minimum sublease payments expected to be received under non-cancellable subleases at the end of the reporting period. Operating leases The lessor should present an asset given under operating lease in its balance sheet under fixed assets. Lease income from operating leases should be recognised in the statement of profit and loss on a straight line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is diminished.
Costs, including depreciation, incurred in earning the lease income are recognised as an expense. Lease income (excluding receipts for services provided such as insurance and maintenance) is recognised in the statement of profit and loss on a straight line basis over the lease term even if the receipts are not on such a basis, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is diminished.
Initial direct costs incurred specifically to earn revenues from an operating lease are either deferred or allocated to income over the lease term in proportion to the recognition of rent income, or are recognised as an expense in the statement of profit and loss in the period in which they are incurred. The depreciation of leased assets should be on a basis consistent with the normal depreciation policy of the lessor for similar assets, and the depreciation charge should be calculated on the basis set out in AS 6, Depreciation Accounting.
To determine whether a leased asset has become impaired, an enterprise applies the Accounting Standard dealing with impairment of assets19 that sets out the requirements for how an enterprise should perform the review of the carrying amount of an asset, how it should determine the recoverable amount of an asset and when it should recognise, or reverse, an impairment loss. A manufacturer or dealer lessor does not recognise any selling profit on entering into an operating lease because it is not the equivalent of a sale.
The lessor should, in addition to the requirements of AS 6, Depreciation Accounting and AS 10, Accounting for Fixed Assets, and the governing statute, make the following disclosures for operating leases: (a) for each class of assets, the gross carrying amount, the accumulated depreciation and accumulated impairment losses at the balance sheet date; and (i) the depreciation recognised in the statement of profit and loss for the period; (ii) impairment losses recognised in the statement of profit and loss for the period; iii) impairment losses reversed in the statement of profit and loss for the period; (b) the future minimum lease payments under non-cancellable operating leases in the aggregate and for each of the following periods: (i) not later than one year; (ii) later than one year and not later than five years; (iii) later than five years; (c) total contingent rents recognised as income in the statement of profit and loss for the period; (d) a general description of the lessor’s significant leasing arrangements; and e) accounting policy adopted in respect of initial direct costs. Disclosures The future minimum lease payments under non-cancellable operating leases in the aggregate and for each of the following periods: (i) not later than one year; (ii) later than one year and not later than five years; (iii) later than five years. (b) total contingent rents recognised as income in the period. (c) a general description of the lessor’s leasing arrangements. Indian and international accounting standards compared:
International Financial Reporting Standards (IFRS) are principles-based Standards, Interpretations and the Framework adopted by the International Accounting Standards Board (IASB). Many of the standards forming part of IFRS are known by the older name of International Accounting Standards (IAS). IAS was issued between 1973 and 2001 by the Board of the International Accounting Standards Committee (IASC). On 1 April 2001, the new IASB took over from the IASC the responsibility for setting International Accounting Standards.
During its first meeting the new Board adopted existing IAS and SICs. The IASB has continued to develop standards calling the new standards IFRS. International accounting standards adopt what is known as finance accounting approach to financial lease transactions. That is, based on the substance of the transaction, a financial lease is recorded as a financing transaction both in the books of the lesser and the lessee. The lessee will accordingly capitalize the asset though the lesser owns it.
The lessee will also record a corresponding liability for payments to the lesser, as if it were a loan not lease. The lesser will bi furcated rentals into principal and interest, and take only the latter as his income. The lessee will also expense the same. While the international accounting standards were concerned about the distortions that would be caused on the lessee’s financial statements if financial leases were not recorded in the above manner, in India, the concern was essentially the lessor’s financial statements.
The distortions in lesson’s reported income – that was the chief issue in India, which is understandable in view of the low penetration ratios of leasing as a percentage of total industrial assets at that time. Hence, Indian accounting standard did not make any substantial change to the way a lessee will account for a lease – in other words, leaving lessee’s accounting virtually untouched, it made provisions only for the lessor’s accounting. Thus, in India:
The lesser would continue to put the asset on his balance sheet; the asset will be off-the-lessee’s-Balance Sheet. The lesser would continue to book rentals as income. The lesser would also depreciate the asset in his books. However, there will be an extra debit or credit to the revenue statement so that the net impact on the lessee’s income statement is only to take the finance charges to income. The lessee would only make a disclosure of the lease liabilities by way of a note to the balance sheet. Hire purchase versus lease
Leasing A lease transaction is a commercial arrangement whereby an equipment owner or Manufacturer conveys to the equipment user the right to use the equipment in return for a rental. In other words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for the right to use the asset during a specified period in return for a mutually agreed periodic payment (the lease rentals). The important feature of a lease contract is separation of the ownership of the asset from its usage Hire purchase
Hire purchase is a type of installment credit under which the hire purchaser, called the hirer, agrees to take the goods on hire at a stated rental, which is inclusive of the repayment of principal as well as interest, with an option to purchase. Under this transaction, the hire purchaser acquires the property (goods) immediately on signing the hire purchase agreement but the ownership or title of the same is transferred only when the last installment is paid. The hire purchase system is regulated by the Hire Purchase Act 1972.
This Act defines a hire purchase as “an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement and includes an agreement under which: 1) The owner delivers possession of goods thereof to a person on condition that such person pays the agreed amount in periodic installments 2) The property in the goods is to pass to such person on the payment of the last of such installments, and 3) Such person has a right to terminate the agreement at any time before the property so passes”.
Hire Purchase VS Lease A lease transaction is a commercial arrangement, whereby an equipment owner or manufacturer conveys to the equipment user the right to use the equipment in return for a rental, while Hire purchase is a type of installment credit under which the hire purchaser agrees to take the goods on hire at a stated rental, which is inclusive of the repayment of principal as well as interest, with an option to purchase. In lease financing no option is provided to the lessee (user) to purchase the goods, where by in Hire urchase option is provided to the hirer (user). Lease rentals paid by the lessee are entirely revenue expenditure of the lessee, while in case of higher purchase only interest element included in the HP installments is revenue expenditure by nature. Components Lease rentals comprise of 2 elements (1) finance charge and (2) capital recovery. HP installments comprise of 3 elements (1) normal trading profit (2) finance charge and (3) recovery of cost of goods/assets.
With a hire purchase agreement, after all the payments have been made, the business customer becomes the owner of the equipment. This ownership transfer either automatically or on payment of an option to purchase fee. The fundamental characteristic of a lease is that ownership never passes to the business customer. For tax purposes, from the beginning of the agreement the business customer is treated as the owner of the equipment and so can claim capital allowances.
Capital allowances can be a significant tax incentive for businesses to invest in new plant and machinery or to upgrade information systems. Instead, the leasing company claims the capital allowances and passes some of the benefit on to the business customer, by way of reduced rental charges. The business customer can generally deduct the full cost of lease rentals from taxable income, as a trading expense. Bibliography www. icai. org www. ifrs. com C. A Module
