AS-19-Leases

CHAPTER
7
AS-19 : Leases
1 Requirements of AS-19
 Classify leases into a Finance leases and operating leases.
 Operating leases-Allocate total rentals to P&L account on a straight-line basis, unless some other
method is more appropriate, even if payments are not along that method.
 Finance lease in lessee's books is recognized as asset & liability. Payments made to be
apportioned between reduction of liability and finance charges. Depreciation to be charged by
lessee on leased asset.
 Finance lease in lessor’s books: If he is a manufacturer/ dealer lessor then recognize profit/loss
on sale and as receivable. Lease rental to be apportioned between reduction of receivable and
finance income. In other cases recognize as receivable. Lease rental to be apportioned between
reduction of receivable and finance income.
 Sale & lease back- Accounting depends on whether resulting lease is finance lease or operating
lease.
2 Applicability
AS-19 does not apply to -
a. lease agreements to explore for or use natural resources, such as oil, gas, timber, metals and
other mineral rights; and
b. licensing agreements for items such as motion picture films, video recordings, plays, manuscripts,
patents and copyrights (covered by AS-26); &
c. lease agreements to use lands (however, lease agreement to use buildings shall be covered).
d. contracts for services that do not transfer the right to use assets from one contracting party to
the other.
3 Lease
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.
Is hire-purchase agreement, a lease?
The definition of a lease includes 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.
3.1 Types of leases/Classification of lease:

State the different types of Leases contemplated in Accounting Standard 19 and discuss briefly. [May 2002]
Define the term Finance Lease. State any three situations when a lease would be classified as finance lease. (Nov. 2012)
Leases are classified into

1. Finance lease
2. Operating lease
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3.2 Finance lease
A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of
an asset. The key word is “substantially all” if all risks and rewards are transferred transaction would
be an outright sale and not lease.
3.3 Operating lease

An operating lease is a lease other than a finance lease. In operating lease, it is only the right to use
asset is transferred. Unlike finance lease there is no transfer of substantially all the risks and rewards
incident to ownership of an asset along with right to use.
3.4.1 Risk & Rewards

Risks include-
- the possibilities of losses from idle capacity or technological obsolescence and
- the possibilities of variations in return due to changing economic conditions.
Rewards may be –
- the expectation of profitable operation over the economic life of the asset and
- gain from appreciation in value or realisation of residual value.
3.4.2 Substance over form (Indicators of Finance Lease)

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction
rather than its form. Examples of situations which would normally lead to a lease being classified as a
finance lease are:
a. the lessor transfers ownership of the asset to the lessee by the end of the lease term (as in the
case of hire purchase agreement);
b. the lessee has the 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 such that, at the inception of
the lease, it is reasonably certain that the option will be exercised (bargain purchase option);
c. the lease term is for the major part of the economic life of the asset even if title is not transferred
(The major part word is not clarified. In our view it should be substantially whole of the life and
not just more than 50%);
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 asset is of a specialised nature such that only the lessee can use it without major
modifications being made.
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LEASE CLASSIFICATION DIAGRAM
Yes
Ownership transferred by the end of lease term
No
Lease contains bargain purchase option which is Yes
so attractive that it is reasonably certain that
lessee will exercise it
No
Lease term for major part of asset's economic life Yes

even if title is not transferred
No
Present value of minimum lease payments Yes

substantially equals the asset fair value as at the
date of inception of the lease
No
Is the lease assets such that it is specialized and

can not be used by any one else other than Yes
lessee without major modifications
No
Substance of the agreement is that the significant Yes

risks and rewards of ownership are transferred to
the lessee
No
Operating Lease Finance Lease
3.4.3 Different classification by lessor and the lessee

Sometimes the application of these definitions to the differing circumstances of the two parties may
result in the same lease being classified differently by the lessor and the lessee.
3.4.4 Changes in lease classification

 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
had the changed terms been in effect at the inception of the lease, the revised agreement is
considered as a new agreement over its revised term.
 Changes in estimates (for example, changes in estimates of the economic life or of the residual
value of the leased asset) or changes in circumstances (for example, default by the lessee),
however, do not give rise to a new classification of a lease for accounting purposes.
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4 Important Terms
(i) 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.
(ii) The lease term is the non-cancelable 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.
(iii) 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 (Guaranteed residual value is):
a. in the case of the lessee, any residual value guaranteed by or on behalf of the lessee; or
b. in the case of the lessor, any residual value guaranteed to the lessor:
i. by or on behalf of the lessee; or
ii. by an independent third party financially capable of meeting this guarantee.
(Or option price in place of residual value.)
(iv) 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.
(v) 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.
(vi) Useful life of a leased asset is either:

a. the period over which the leased asset is expected to be used by the lessee; or
b. the number of production or similar units expected to be obtained from the use of the asset by
the lessee.
(vii) Residual value of a leased asset is the estimated fair value of the asset at the end of the lease
term.
(viii) Unguaranteed residual value of a leased asset is the amount by which the residual value of
the asset exceeds its guaranteed residual value.
(ix) 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.
(x) Unearned finance income is the difference between:

a. the gross investment in the lease; and
b. the present value (at the interest rate implicit in the lease) of:
i. the minimum lease payments under a finance lease from the standpoint of the lessor; and
ii. any unguaranteed residual value accruing to the lessor.
(xi) Net investment in the lease is the gross investment in the lease less unearned finance
income. (It will be fair value of the asset)
(xii) 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 under a finance lease from the standpoint of the lessor; and
b. any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the leased
asset.
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(xiii) 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.
5 Accounting for Leases

5.1 Accounting for Finance Leases in the books of lessee (users)
1. Initial recognition: At its inception, a finance lease, should be recognised as an asset and a
liability at the lower of the fair value of the leased asset and the present value of the minimum
lease payments from the standpoint of the lessee. In calculating the present value the discount
rate is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee's
incremental borrowing rate should be used.
2. Accounting for lease payments: Lease payments should be apportioned between the finance
charge and the reduction of the outstanding liability. The finance charge should be allocated to
periods during the lease term so as to produce a constant periodic rate of interest on the
remaining balance of the liability for each period.
3. Initial Direct Costs: Initial direct costs are often incurred in connection with specific leasing
activities, as in negotiating and securing leasing arrangements. These costs are included as part
of the amount recognised as an asset under the lease.
4. Depreciation on the leased asset: The depreciation policy for a leased asset should be
consistent with that for depreciable assets, which are owned. For depreciation Accounting
Standard (AS) 6, Depreciation Accounting be followed.
5. Presentation of lease asset and liability in the balance sheet: The liability for a leased
asset should not be presented as a deduction from the leased asset in the financial statements.
The liability for a leased asset should be presented separately in the balance sheet as a current
liability or a long-term liability as the case may be. Future installments under hire-purchase
agreements or finance leases should be shown as secured loans (long term liability). Installment
already due should be shown as current liability.
6. Disclosures: The lessee should, make the following disclosures for finance leases:
a. assets acquired under finance lease as segregated from the assets owned;
b. for each class of assets, the net carrying amount at the balance sheet date;
c. a reconciliation between the total of minimum lease payments at the balance sheet date and
their present value. In addition, an enterprise should disclose the total of minimum lease
payments at the balance sheet date, 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;
Illustration 1 'A' gives to 'B' a machine on lease at Rs. 10,000/- per annum for 5 years lease rental
payable at the end of year. Rs. 5,000/- is minimum amount guaranteed by 'B' at the end of lease
term. Rs. 2,000/- is unguaranteed residual value. Fair value of the asset is 40,000/-. Calculate
Interest rate implicit in the lease.
Solution. Interest rate implicit in the lease is 12%. It is the rate of discounting at which present
value of gross investment = fair value. This rate can be ascertained by using a complicated
mathematical formula which will require use of Log and Antilog. Alternatively it can be ascertained by Trial
and Error & Interpolation, as explained below. It is same as IRR-Internal Rate of Return calculation used in
Financial Management.
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Year Discount Minimum lease payments & Present
factor @10% unguaranteed residual value value
1 0.909 Lease rental 10,000 9,090
2 0.826 Lease rental 10,000 8,260
3 0.751 Lease rental 10,000 7,510
4 0.683 Lease rental 10,000 6,830
5 0.621 Lease rental 10,000 6,210
5 0.621 Residual value 7,000 4,347
57,000 42,247
As the present value at 10% rate Rs. 42,247 is higher than fair value of the asset Rs. 40,000/-, a
higher discounting rate will be considered say 14%.

factor @14% Unguaranteed residual value value
1 0.877 10,000 8,770
2 0.769 10,000 7,690
3 0.675 10,000 6,750
4 0.592 10,000 5,920
5 0.519 10,000 5,190
5 0.519 7,000 3,633
57,000 37,953
As the present value at 14%, rate is lower than the fair value of asset, we can say that the required
rate is more than 10%, but less than 14% and by interpolation we can get the approximate rate as
follows:
4 14  10 
  2247 42247  40000  2.09%
4294 42247  37953 
Implicit rate of interest  10  2.09%  12.09%. say approx  12%.
Illustration 2 Take the figures of Illustration 1 & show how lease will be accounted in the books
of 'B' (lessee/user).
Solution. Lessee will account the lease at lower of the following two figures: (i) Fair value of asset
which is Rs. 40,000/- & (ii) Present value of minimum lease payments from the lessees stand point
which is Rs. 38,885/-, calculated as follows:
Year Discount Minimum lease Present
factor @12% payments value
1 0.893 10,000 8,930
2 0.797 10,000 7,970
3 0.712 10,000 7,120
4 0.636 10,000 6,360
5 0.567 10,000 5,670
5 0.567 5,000 2,835
55,000 38,885
Note
1. Unguaranteed residual value Rs. 2,000 is not part of minimum payment for lessee. The lessee will
account lease at Rs. 38,885.
2. Difference comes because of unguaranteed residual value from lessors standpoint, which is not
considered (by the lessee) here. Hence, if there is no unguaranteed residual value or residual
value guaranteed by independent third party then the above two figures will be same.
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Break up of lease payment into finance charges and reduction in liability will be as follows:
Year Amount Lease Finance Reduction Closing

payable payment charges in liability payable
@12%
Down
0 38,885 payment Nil Nil Nil 38,885
38,885 x 12% 10000 - 4666 38885-5334 =
1 38,885 10,000 = 4666 = 5334 33551
2 33,551 10,000 4026 5974 27577
3 27,577 10,000 3309 6691 20886
4 20,886 10,000 2506 7494 13392
5 13,392 10,000 1607 8393
5,000 - 5000 (-) 1*
* Note. Difference is due to approximation involved. It will be adjusted by taking 5 th year interest at
Rs. 1608/- instead of Rs. 1607/-
Accounting in the books of lessee, assuming that depreciation is charged @20%

Beginning of year 1 Machine a/c Dr. 38,885
To lessor (A) a/c 38,885
End of year 1 Lessor a/c Dr. 5,334

Finance charges a/c Dr. 4,666
To Bank a/c 10,000
Depreciation a/c Dr. 7,777

To Machinery a/c 7,777
End of year 2 Lessor a/c Dr. 5,974

Finance charges a/c Dr. 4,026
To Bank a/c 10,000
Depreciation a/c Dr. 7,777
To Machinery a/c 7,777
Note: In the same way accounting will continue for 3rd, 4th & 5th year.
Illustration 3 An enterprise (the lessee) acquires a machinery on lease from a leasing company (the
lessor) on January 1, 20X0. The lease term covers the entire economic life of the machinery, i.e. 3
years. The fair value of the machinery on January 1, 20X0 is Rs. 2,35,500. The lease agreement
requires the lessee to pay an amount of Rs. 1,00,000 per year beginning December 31, 20X0. The
lessee has guaranteed a residual value of Rs. 17,000 on December 31, 20X2 to the lessor. The lessor,
however, estimates that the machinery would have a salvage value of only Rs. 3,500 on December
31, 20X2. Show the accounting entries in the books of the lessee.
Solution. The present value of minimum lease payments from the stand point of the lessee is Rs.
2,35,500. The estimate of salvage value by lessor lower than that guaranteed by lessee, has no
relevance in calculation and accounting either for lessor or for lessee.
The lessee would record the machinery as an asset at Rs. 2,35,500 with a corresponding liability
representing the present value of lease payments over the lease term (including the guaranteed
residual value).
The interest rate implicit in the lease is calculated at 16% (approx.).
Year Finance Payment Reduction in Outstanding
charge (Rs.) outstanding liability
(Rs.) liability (Rs.) (Rs.)
Year 1 (January 1) 2,35,500
(December 31) 37,680 1,00,000 62,320 1,73,180
Year 2 (December 31) 27,709 1,00,000 72,291 1,00,889
Year 3 (December 31) 16,142 1,00,000 83,858 17,031*
* Residual value is Rs. 17000, Rs. 31 is the difference due to rounding off.
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Entries in the books of lessee (User)
Year 1 Rs. Rs.
1st January Leased Asset a/c. Dr. 2,35,500
To Finance lease liability a/c. 2,35,500
st
31 December Finance lease liability a/c. Dr. 62,320
Finance expense a/c. Dr. 37,680
To Bank a/c. 1,00,000
Year 2 Finance lease liability a/c. Dr. 72,291

31st December Finance expense a/c. Dr. 27,709
To Bank a/c. 1,00,000
Year 3 Finance lease liability a/c. Dr. 83,889

31st December Finance expense a/c. Dr. 16,111
To Bank a/c. 1,00,000
Finance lease liability a/c. Dr. 17,000

To Bank a/c. 17,000
(Residual value paid & asset acquired)
In addition to above accounting for depreciation will also be made every year.
Illustration 4 In illustration 3 above, suppose the lessor estimates that the machinery would have a
salvage value of Rs. 17,000 on December 31, 20X2. The lessee, however, guarantees a residual value
of Rs. 5,000 only. What is the amount at which the finance lease will be initially recognized?
Solution. The interest rate implicit in the lease in this case would remain unchanged at 16%
(approx.). The present value of the minimum lease payments from the standpoint of the lessee (it
includes residual value Rs. 5000 and not Rs. 17000), using this interest rate implicit in the lease,
would be Rs. 2,27,805. As this amount is lower than the fair value of the leased asset (Rs. 2,35,500),
the lessee would recognise the asset and the liability arising from the lease at Rs. 2,27,805.
Illustration 5 A Ltd. has accounted for assets acquired under finance lease by charging of the
annual lease rentals to the statement of profit and loss account. Comment on this policy followed by
the company.
Solution. Transactions and other events are accounted for and presented in accordance with their
substance and financial reality and not merely with their legal form. While 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 to 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 enterprise are understated thereby distorting financial ratios. It is
therefore appropriate that a finance lease be recognised in the lessee's balance sheet both as an
asset and as an obligation to pay future lease payments.
The sum of the depreciation expense for the asset and the finance expense for the period is rarely
the same as the lease payments payable for the period, and it is, therefore, inappropriate simply to
recognise the lease payments payable as an expense in the statement of profit and loss. Hence, the
profit and loss account and balance sheet will not reflect a true and fair view of the profit or loss and
financial position.
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5.2 Operating Leases in the books of lessee (User)
 Lease payments (excluding costs for services such as insurance and maintenance) should be
recognised as an expense in the statement of profit and loss on a straight line basis over the
lease term even if the payments are not on that basis unless another systematic basis is more
representative of the time pattern of the user's benefit.
 The lessee should make the following disclosures for operating leases:
a. the total of future minimum lease payments under non-cancellable operating leases for each
of the following periods:
b. lease payments recognised in the statement of profit and loss for the period, with separate
amounts for minimum lease payments and contingent rents;
Illustration 6 X gives on lease, a machine having 10 years Life to Y, for 3 years at a lease rent of
Rs. 10,000/- per annum.
Solution. 'Y' i.e. lessee (user) will pass following entry in all the three year
Lessee rent a/c Dr. 10,000
To Bank a/c 10,000
(lease rent will be charged as on expense in the P & L)
Illustration 7 In Illustration 6 If lease rent in 1st year 8,000, 2nd year 10,000 & 3rd year 12,000, then
how Y will account it.
Solution. Y can either account Rs. 10,000 in each of the three years as lease rent, as follows:
1st year Lease rent a/c Dr. 10,000
To Bank a/c 8,000
To Provision for lease rent 2,000
2nd year Lease rent a/c Dr. 10,000

To Bank a/c 10,000
3rd year Lease rent a/c Dr. 10,000

Provision for lease rent a/c Dr. 2,000
To Bank a/c 12,000
Or
If Y considers that the actual payments in each year represents the proper value of use of the asset
then amount paid in the respective year will be debited as lease rent.
The above payment structuring of lease rentals is called ballooning.
5.3 Finance Leases in the Financial Statements of Lessors (Owner) (other

than manufacturer or dealer lessor)
1. The lessor should recognise assets given under a finance lease in its balance sheet as a
receivable at an amount equal to the net investment in the lease.
2. Under a finance lease substantially all the risks and rewards incident to legal ownership are
transferred by the lessor. Thus, the lease payment receivable is treated by the lessor as
repayment of principal, i.e., net investment in the lease, and finance income to reimburse and
reward the lessor for its investment and services.
3. The recognition of finance income should be based on a pattern reflecting a constant periodic
rate of return on the net investment of the lessor outstanding. Lease payments, relating to the
accounting period, excluding costs for services, the principle is reduced from the lease receivable
and the finance income is credited to P&L.
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4. Estimated unguaranteed residual values used in computing the lessor's gross investment in a
lease are reviewed regularly. If there has been a reduction in the estimated unguaranteed
residual value, the income allocation over the remaining lease term is revised. Any reduction in
respect of amounts already accrued is recognised immediately. An upward adjustment of the
estimated residual value is not made.
5. Initial direct costs, such as commissions and legal fees, are often incurred by lessors in
negotiating and arranging a lease. For finance leases, these initial direct costs are incurred to
produce finance income and are either recognised immediately in the statement of profit and loss
or allocated against the finance income over the lease term.
Illustration 8 Account the lease in the books of 'A' (lessor/owner). (Figures of Illustration 1
considered here)
Solution. Break-up of lease payment into finance income and reduction in receivable.
Yea Amount Lease payment Finance Reduction in Closing
receivab charges receivable receivable
le @12%
0 40,000 Down payment Nil Nil Nil 40000
40,000 x 12% 10000 - 4800 = 40000 - 5200 =
1 40,000 10,000 = 4800 5200 34800
2 34,800 10,000 4176 5824 28976
3 28,976 10,000 3477 6523 22453
4 22,453 10,000 2694 7306 15147
5 15,147 10,000 1818 8182
7,000 - 7000 (-) 35*
*Note: Difference is due to approximation involved. It will be adjusted by taking 5 th year interest at
Rs. 1853/- instead of Rs. 1818/-
Accounting in the books of lessor (owner)

Beginning of Lessee (B) a/c Dr. 40,000
year 1 To Asset sold a/c 40,000
(The difference between the carrying amount of asset & this sale
value will be transferred to P&L a/c as profit or loss) or it may be
credited to bank a/c being payment made to the supplier of asset.
End of year 1 Bank a/c Dr. 10,000

To lessee a/c 5,200
To Finance income a/c 4,800
End of year 2 Bank a/c Dr. 10,000

To lessee a/c 5,824
To Finance income a/c 4,176
Note: The same way accounting will continue for 3rd, 4th & 5th year.
Illustration 9 In 3rd year suppose 'A' estimates that unguaranteed residual value is nil i.e. he is
expecting residual value at 5,000/- instead of 7,000/-.
Solution. In this case at the end of 3 rd year the amount receivable balance will be 22,453/- as per
original estimates, but now as per revised estimates it should be 20,886/- (i.e. present value of
10,000/- at the end of 4th year and 15,000/- at the end of 5th year).
Therefore, the difference will be adjusted by following entry.
Finance Income a/c Dr. 1567
To lessee a/c (22,453 - 20,886) 1567
Note: Upward revision of unguaranteed residual value is not allowed.
Illustration 10 In Illustration 1. If lessor quotes interest rate of 10% and increases fair value to Rs.
42,250/- commercial rate of interest in similar case is 12%. The item has a cost Rs. 35,000/- and
normal selling price of Rs. 40,000/-.
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Solution. In such case if 42,250/- is taken as fair value the profit will be inflated by Rs. 2250/- and
finance income over the lease term will be lower being taken at 10%. This is not permitted. In this
case fair value should be taken at 40,000/- taking 12% interest rate.
5.3.1 Accounting by manufacturer or dealer lessor

A finance lease of an asset by a manufacturer or dealer lessor is called a sales type lease. It gives
rise to two types of income:
(a) the profit or loss equivalent to the profit or loss resulting from an outright sale of the asset being
leased, at normal selling prices, reflecting any applicable volume or trade discounts; and
(b) the finance income over the lease term (in the manner discussed in para 5.3 above)
 The transaction of sale should be recognized in the statement of profit and loss for the period, in
accordance with the policy followed for outright sales.
 If artificially low rates of interest are quoted, profit on sale should be restricted to that which
would apply if a commercial rate of interest were charged.
 The sales revenue recorded at the commencement of a finance lease term by a manufacturer or
dealer lessor is the lower of fair value of the asset and the present value of the minimum lease
payments accruing to the lessor computed at a commercial rate of interest.
 The cost of sale recognised at the commencement of the lease term is the cost, or carrying
amount if different, of the leased asset less the present value of the unguaranteed residual value.
 The difference between the sales revenue and the cost of sale is the selling profit, which is
recognised in accordance with the policy followed by the enterprise for sales. (The sale value &
cost of the asset sold from both the present value of unguaranteed residual value is deducted).
 Initial direct costs are recognised as an expense at the commencement of the lease term because
they are mainly related to earning the manufacturer's or dealer's selling profit.
Illustration 11 Account the lease in the books of 'A' ( Manufacturer lessor/owner).

(Figures of Illustration 1 considered here)
Solution. Fair value is Rs.40,000 Cost of the asset sold is (assumed) Rs.35,000.
The present value of unguaranteed residual value = 2,000 X 0.567 = 1,134
Initial recognition of lease will be as follows:
Lessee (B) /Lease receivable a/c Dr. 40,000
To Sales a/c 38,866
To Cost of sales a/c 1,134
In P&L a/c Sales income will appear at Rs. 38,866 and Cost of sales at Rs. 33,866 (35,000 – 1,134)
resulting in to profit of Rs. 5,000.
Break-up of lease payment into finance income and reduction in receivable and its accounting will be
same as done in Illustration 8.
5.3.2 Disclosures
The lessor should make the following disclosures for finance leases:
a. a reconciliation between the total gross investment in the lease, and the present value of minimum
lease payments receivable at the balance sheet date. In addition, an enterprise should disclose the
total gross investment in the lease and the present value of minimum lease payments receivable at
the balance sheet date, for each of the following periods:
b. unearned finance income;
c. the unguaranteed residual values accruing to the benefit of the lessor;
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5.4 Operating Leases in the books of lessor (Owner)
 The lessor should present an asset given under operating lease in its balance sheet under fixed
assets.
 Lease income from operating leases (excluding receipts for services provided such as insurance
and maintenance) should be 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.
 However, if another systematic basis is more representative of the time pattern in which benefit
derived from the use of the leased asset is diminished, then recognition will be on that basis
instead of straight line basis.
 Costs, including depreciation, incurred in earning the lease income are recognised as an expense.
 Initial direct costs incurred specifically to earn revenues from an operating lease are either
deferred and 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.
Disclosures:
The lessor should, 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:
Illustration 12 In Illustration 6 above. 'X' (lessor) will treat machine as a fixed asset and will charge
depreciation as per method followed by it. The lease rental will be recognised as income every year.
Following entry will come in 1st, 2nd & 3rd year.
Bank a/c Dr. 10,000
To lease rental income a/c 10,000
Illustration 13 In Illustration 7 above. 'X' (lessor) will either recognise Rs. 10,000/- as income in
each of the three years as follows:
1st year Bank a/c Dr. 8,000
Lease rent receivable a/c Dr. 2,000
2nd year Bank a/c Dr. 10,000

3rd year Bank a/c Dr. 12,000

To lease rent receivable a/c 2,000
Or
If X considers that the actual lease rent received in each year represents the proper value of asset
used, then the actual lease rent received will be credited as lease rent income.
63
Comparative Table : Lease
Item For lessor For lessee
Finance lease
1) Minimum a) Periodic payment over lease term a) Periodic payment over lease term
lease payment and and
b) Residual value guaranteed by b) Residual value guaranteed by lessee
lessee or on his behalf (or option or on his behalf (or option price if
price if favourable) favourable)
c) Residual value guaranteed by c) NA
independent third party.
2) Gross Minimum lease payment plus NA

investment in Unguaranteed residual value
the lease
3) Net Present value (at implicit interest rate) NA
investment in of gross investment i.e. equal to fair
the lease value
4) Asset, Net investment in the lease i.e. fair Lower of the following two
liability to be value of the asset a) Present value (at implicit interest
recognized at rate if known otherwise at lessees
(value) incremental borrowing rate) of
minimum lease payment.
b) Fair value of the asset.
5) Depreciation Not applicable Charge as per AS-6

on leased asset
6) Discounting Interest rate implicit in the lease a) Interest rate implicit in the lease
rate b) If (a) is not known then lessees
incremental borrowing rate.
7) Resulting
items –
Assets Lease receivable a/c. Leased asset (fixed asset)
Liabilities - Lease payable a/c.
Incomes Finance income -
Expenses - Finance expense and depreciation
Lease rental is Credited to lease receivable and Debited to lease payable and finance
allocated and finance income. expense.
8) Initial direct In case of manufacturer or dealer Initial direct cost incurred in negotiating
cost incurred lessor – Charge to P&L A/c. and securing the lease is to be
immediately. capitalized.
In case of other – Either charge to P&L
immediately or allocate against finance
income over lease term.
Operating
lease
9) Initial direct Either charge to P&L immediately or Incase of operating lease AS-19 is silent.
cost incurred allocate in proportion to lease income Such initial cost should be immediately
over lease term. expensed in view of the authors.
63
Item For lessor For lessee
10) Resulting
items 
Assets Fixed asset (given on lease) -
Liabilities - -
Incomes Lease rental -
Expenses Depreciation Lease rental
6 Sale and Leaseback Transactions

Write short note on Sale and Lease Back Transactions as per Accounting Standard 19. [Nov. 2002]
 A sale and leaseback transaction involves the sale of an asset by the vendor and the leasing of
the same asset back to the vendor.
 The lease payments and the sale price are usually interdependent as they are negotiated as a
package.
 AS-19 gives treatment only for lessee who sales an asset and leased it back. It is silent for lessor
that means usual accounting for lessor should be applied in case of sale and leaseback also.
 Treatment of sale and leaseback will depend upon whether it results into
a) Finance lease or b) Operating lease
6.1 Sale and Leaseback Transactions resulting in Finance Lease

 If a sale and leaseback transaction results in a finance lease, any excess (profit) or deficiency
(loss) of sales proceeds over the carrying amount should not be immediately recognised as
income or loss in the financial statements of a seller-lessee. Instead, it should be deferred and
amortised over the lease term in proportion to the depreciation of the leased asset.
Illustration 14 A Limited has a Truck (book value Rs. 1,00,000), Economic life = 10 years, Residual
value = Nil. At the beginning of the 6 th year, If A Limited entered into sale and lease back transaction
in respect of the Truck resulting into finance lease. Amount received = Rs. 60,000. Yearly rental = Rs.
18,000, Fair value of the Truck = Rs. 60,000, Interest rate implicit in the lease = 15%. Show
accounting entries for the transaction in accordance with AS-19.
Solution. The present value of minimum lease payments is Rs. 60,000 which is equal to fair value.
The allocation between finance charge and reduction in liability is shown in the table below –
Year Payment Finance Reduction in Outstanding

(Rs.) charge (Rs.) outstanding liability liability (Rs.)
(Rs.)
Year 6 60,000
18,000 9,000 9,000 51,000
Year 7 18,000 7,650 10,350 40,650
Year 8 18,000 6,098 11,902 28,748
Year 9 18,000 4,312 13,688 15,060
Year 10 18,000 2,940 15,060 Nil
Journal Entries in the books of Seller Lessee

Year DR. CR.
6 Bank a/c. Dr. 60,000
To Deferred income a/c. 10,000
To Truck a/c. 50,000
63
(Amount received in respect of sale and lease back of Truck, having
book value Rs. 50,000, gain of Rs. 10,000 treated as deferred income)
Leased truck a/c. Dr. 60,000

To Lease obligation a/c. 60,000
(Finance lease of truck under sale and lease back recognized)
Lease obligation a/c Dr. 9,000

Finance charges a/c. Dr 9,000
To Bank a/c 18,000
(Lease payments for year 6)
Deferred income a/c. Dr. 2,000

To Profit and loss a/c. 2,000
(Deferral of gain on sale and lease back recognized in P&L in
proportion to depreciation)
P&L account Dr. 12,000

To Leased truck account 12,000
(Depreciation on leased truck = 60,000/5 )
7 Lease obligation a/c Dr. 10,350

To Bank a/c 18,000

(Deferral of gain on sale and lease back)

(Depreciation on leased truck)

To Bank a/c 18,000

To Bank a/c 18,000
63
To Bank a/c 18,000

(Depreciation on lease truck)
6.2 Sale & lease back resulting into operating lease

If sale and leaseback results into operating lease, it will be classified into three situations –
i) Transaction (i.e. sale) is established at fair value: Then profit or loss (i.e. the difference
between sale value and carrying amount) be immediately recognized in P&L.
ii) Transaction (i.e. sale) is established at below fair value: Then profit or loss (i.e. the
difference between sale value and carrying amount) be immediately recognized in P&L except if
loss is compensated by lower lease payment, then loss should be amortized in proportion to lease
payments.
iii) If sale price is above fair value: Then the excess of sale price over fair value shall be deferred
and amortized over the lease period. The profit or loss (i.e. the difference between reduced sale
price and carrying amount) be recognized to P&L a/c.
Lessee Sale price = Fair Sale price < Fair value Sale price > Fair value
value
(1) Sale SP 50, FV 50, SP 50, FV 60, CA 50 SP 50, FV 45, CA 50
value = CA 50 No profit & loss on sale Credit 5 of sale to deferred
Carrying No profit & loss on income
amount sale Loss 5 (reduced SP 45 – CA 50)
charge to P&L
value < CA 55 Loss 5 be charged to P&L 5 of sale (SP 50 – FV 45)
Carrying Loss 5 charge to If it is compensated by lower credited to deferred income
amount P&L lease rental then defer and Loss of 10 (reduced SP 45 – CA
amortize in proportion to lease 55) charge to P&L
payment.
If suppose CA is 65 then loss
of 5 (difference between FV &
CA) must be charged to P&L
(clause 52). Only loss of 10
can be deferred.
value > CA 45 Profit 5 credit to P&L Reduce sale by 5 credit to
Carrying Profit 5 credit to deferred income
amount P&L No profit or loss
Lessor Debit asset with Debit asset with 50. Debit asset with 50.
In (1), 50. Credit lease rentals to P&L Credit lease rentals to P&L.
(2) & (3) Credit lease rentals
above to P&L. Charge deprecation as per AS- Charge deprecation as per
Charge deprecation 6. AS-6.
as per AS-6.
63
PRACTICAL EXAM QUESTIONS
Problem No.1: (Nov. 2013) Classify the following into either operating or finance lease:
(i) Lessee has option to purchase the asset at lower than fair value, at the end of lease term;
(ii) Economic life of the asset is 7 years, lease term is 6 years, but asset is not acquired at the
end of the lease term;
(iii) Economic life of the asset is 6 years. lease term is 2 years, but the asset is of special
nature and has been procured only for use of the lessee:
(iv) Present value (PV) of Minimum lease payment (MLP) = "X". Fair value of the asset is "Y".
Solution:
(i) Finance lease
(ii) Finance lease
(iii) Finance lease
(iv) Operating lease
Problem No. 2: (May 2012) X Ltd. sold JCB Machine having WDV of Rs. 50 Lakhs to Y Ltd. for Rs.
60 Lakhs and the same JCB was leased back by Y Ltd. to X Ltd. The lease is operating lease.
Comment according to relevant Accounting Standard if
a. Sale price of Rs. 60 Lakhs is equal to fair value.
b. Fair value is Rs. 50 Lakhs and sale price is Rs. 45 Lakhs.
c. Fair value is Rs. 55 Lakhs and sale price is Rs. 62 Lakhs.
d. Fair value is Rs. 45 Lakhs and sale price is Rs. 48 Lakhs.
Solution: These is Sale & lease back resulting in to operating lease as per AS-19.
(i)
Profit Rs.10 lakhs (SP 60 -- WDV 50) will be recognised to Profit & Loss A/c
(ii)
5 Lakh will be debited to Profit & Loss A/c as ‘Loss on Sale of Fixed asset’. But if loss is compensated
by lower lease rental than the same shall be deferred and recognized in proportion to lease
rental over lease period.
(iii)
Sale value in excess of fair value i.e. 62- 55 = 7 lakh shall be deferred and recognized in proportion
to lease rental over lease period. Profit with reference to the reduced selling price 55 – 50 = 5
lakh shall be recognized in P&L immediately.
(iv)
Sale value in excess of fair value i.e. 48 - 45 = 3 lakh shall be deferred and recognized in proportion
to lease rental over lease period. Loss with reference to the reduced selling price 45 – 50 = - 5
lakh shall be recognized in P&L immediately.
Problem No. 3: [May 2010] B&P Ltd. availed a lease from N&L Ltd. The conditions of the lease
terms are as under:
(i) Lease period is 3 years, in the beginning of the year 2009, for equipment costing Rs.
10,00,000 and has an expected useful life of 5 years.
(ii) The Fair market value is also Rs. 10,00,000.
(iii) The property reverts back to the lessor on termination of the lease.
(iv) The unguaranteed value is estimated at Rs. 1,00,000 at the end of the year 2011.
(v) 3 equal annual payments are made at the end of each year.
Consider IRR = 10%
The present value of Re. 1 due at the end of 3rd year at 10% rate of interest is Re. 0.7513.
The present value of annuity of Re. 1 due at the end of 3 rd year at 10% IRR is Rs. 2.4868.
63
State whether the lease constitute finance lease and also calculate unearned Finance income.
Solution: Annual lease payment is not specified hence same is calculated using IRR. At IRR the
present value Gross investment in the lease is equal to Fair value of leased asset.
Fair value of leased asset Rs.10,00,000
Less: Present value of unguaranteed residual value (1,00,000 X 0.7513) 75,130
Balance is the Present value of 3 annual lease payment 9,24,870
Therefore annual lease payment = 9,24,870 / 2.4868 = 3,71,912
Gross Investment = (3,71,912 X 3) + 1,00,000 = 12,15,736

Less: Fair value of leased asset 10,00,000
Unearned finance income 2,15,736
Present value of minimum lease payment is substantially equals the fair value of asset at the
inception of lease hence it should be classified as finance lease.
Problem No. 4: (Nov. 2011) An equipment having expected useful life of 5 years, is leased for 3
years. Both the cost and the fair value of the equipment are Rs. 6,00,000. The amount will be paid in
3 equal installments and at the termination of lease, lessor will get back the equipment. The
unguaranteed residual value at the end of 3 years is Rs. 60,000. The IRR of the investment is 10%.
The present value of annuity factor of Rs. 1 due at the end of 3 rd year at 10% IRR is 2.4868. The
present value of Rs. 1 due at the end of 3 rd Year at 10% rate of interest is 0.7513. State with reason
whether the lease constitutes finance lease and also compute the unearned finance income.
Solution:
Fair value of leased asset (stated to be equal to its cost) Rs.6,00,000
Less: Present value of unguaranteed residual value (60,000 X 0.7513) 45,078
Gross Investment = (2,23,147 X 3) + 60,000 = 7,29,441

Present value of minimum lease payment (5,54,922/6,00,000 X 100 = 92.49%) is substantially equals
the fair value of asset at the inception of lease hence it should be classified as finance lease.
Problem No. 5: (May 2011) Lessee Ltd. took a machine on lease from Lessor Ltd., the fair value
being Rs. 7,00,000. The economic life of machine as well as the lease term is 3 years. At the end of
each year Lessee Ltd. pays Rs. 3,00,000. The Lessee has guaranteed a residual value of Rs. 22,000
on expiry of the lease to the Lessor. However Lessor Ltd., estimates that the residual value of the
machinery will be only Rs. 15,000. The implicit rate of return is 15% p.a. and present value factors at
15% are 0.869, 0.756 and 0.657 at the end of first, second and third years respectively.
Calculate the value of machinery to be considered by Lessee Ltd. and the finance charges in each
year.
Solution:
Present value of minimum lease payment
Year Lease rental P.V.F. Present Value
1 3,00,000 .869 2,60,700
2 3,00,000 .756 2,26,800
3 3,00,000 .657 1,97,100
Residual Value 22,000 .657 14,454
63
6,99,054 (a)
Fair Value 7,00,000 (b)
Lessee will account machinery at lower of the two i.e. at 6,99,054.
Working of Finance Charges:
Year Opening Balance Interest Repayment Closing Balance
1 6,99,054 1,04,858 3,00,000 5,03,912
2 5,03,912 75,587 3,00,000 2,79,499
3 2,79,499 41,925 3,22,000 –576*
rd
This is rounding off difference and interest of 3 year to be increased to Rs. 42,501.
Problem No. 6: (Nov. 2011) An equipment having expected useful life of 5 years, is leased for 3
years. Both the cost and the fair value of the equipment are Rs. 6,00,000. The amount will be paid in
3 equal installments and at the termination of lease, lessor will get back the equipment. The
unguaranteed residual value at the end of 3 years is Rs. 60,000. The IRR of the investment is 10%.
The present value of annuity factor of Rs. 1 due at the end of 3 rd year at 10% IRR is 2.4868. The
present value of Rs. 1 due at the end of 3 rd Year at 10% rate of interest is 0.7513. State with reason
whether the lease constitutes finance lease and also compute the unearned finance income.
Solution:
Lease rental assumed as ‘r’ p.a.
Gross Investment in the lease = Minimum lease payment + Unguaranteed value
= (R X 3) + 60,000
Implicit rate in the lease is given at 10%. Hence net investment in the lease i.e. present value of the
gross investment will be fair value which is given as 6,00,000. Equating this we get:
R X 2.4868 + 60,000 X 0.7513 = 6,00,000
R X 2.4868 = 6,00,000 – 45,078
R = 5,54,922/2.4868 = 2,23,147 Lease rental p.a.
Calculation of Unearned finance income:

Year Opening Balance Interest @10% Total Recovered Closing balance
1 6,00,000 60,000 6,60,000 2,23,147 4,36,853
2 4,36,853 43,685 4,80,538 2,23,147 2,57,391
3 2,57,391 25,739 2,83,130 2,23,147 59,983
3 59,983 17 60,000 60,000 Nil
Note: Rs.17 is the difference due to rounding off involved, the same to be adjusted by increasing the
interest of 3rd year.
Problem No. 7: (Nov. 2012) Annual lease rent = Rs. 40,000 at the end of each year
Lease period = 5 years
Guaranteed residual value = Rs. 14,000
Fair value at the inception (beginning) of lease = Rs. 1,50,000
Interest rate implicit on lease is 12.6%. The present value factors at 12.6% are 0.89, 0.79, 0.7,
0.622, 0.552 at the end of first, second, third, fourth and fifth year respectively.
Show the Journal entry to record the asset taken on finance lease in the books of the lessee.
Solution:
In the books of Lessee
Journal entry
Rs. Rs.
Asset A/c Dr. 1,49,888
63
To Lessor A/c 1,49,888
(Being recognition of finance lease as an asset and a liability)
Working Note:
Year Lease Payments Discounting Present Value

Rs. Factor (12.6%) Rs.
1 40,000 0.89 35,600
2 40,000 0.79 31,600
3 40,000 0.70 28,000
4 40,000 0.622 24,880
5 40,000 0.552 22,080
5 14,000 (GRV) 0.552 7,728
1,49,888
Problem No. 8: (May 2014) What do you understand by the term "Interest rate implicit on lease"?
Calculate the interest rate implicit on lease from the following details:
Annual Lease Rent : Rs.80,000 at the end of each yr
Lease Period : 5 Years
Guaranteed Residual Value : Rs. 40,000
Unguaranteed Residual Value : Rs. 24,000
Fair Value at the inception of the lease : Rs.3,20,000
Discounted rates for the first 5 years are as below:
At 10% 0.909, 0.826, 0.751, 0.683, 0.621
At 14% 0.877, 0.769, 0.675, 0.592, 0.519
Solution: Interest rate implicit in the lease is the rate of discounting at which present value of gross
investment = fair value. It can be ascertained by Trial and Error & Interpolation, as explained below.
factor @10% unguaranteed residual value value
1 0.909 Lease rental 80,000 72,720
2 0.826 Lease rental 80,000 66,080
3 0.751 Lease rental 80,000 60,080
4 0.683 Lease rental 80,000 54,640
5 0.621 Lease rental 80,000 49,680
5 0.621 Residual value 64,000 39,744
3,42,944
As the present value at 10% rate Rs. 3,42,944 is higher than fair value of the asset Rs. 3,20,000/-, a
higher discounting rate will be considered say 14%.

factor @14% Unguaranteed residual value value
1 0.877 80,000 70,160
2 0.769 80,000 61,520
3 0.675 80,000 54,000
4 0.592 80,000 47,360
5 0.519 80,000 41,520
5 0.519 64,000 33,216
4,64,000 3,07,776
As the present value at 14%, rate is lower than the fair value of asset, we can say that the required
rate is more than 10%, but less than 14% and by interpolation we can get the approximate rate as
follows:
63
Problem No. 9: (Nov. 2014) A machine having expected useful life of 6 years, is leased for 4
years. Both the cost and the fair value of the machinery are Rs.7,00,000. The amount will be paid in
4 equal instalments and at the termination of lease, lessor will get back the machinery. The
unguaranteed residual value at the end of the 4 th year is Rs.70,000. The IRR of the investment is
10%. The present value of annuity factor of Rs.1 due at the end of 4 th year at 10% IRR is 3.169. The
present value of Rs. 1 due at the end of 4th year at 10% rate of interest is 0.683.
State with reasons whether the lease constitutes finance lease and also compute the unearned
finance income.
Solution: Annual lease payment is not specified hence same is calculated using IRR. At IRR the
present value Gross investment in the lease is equal to Fair value of leased asset.
Fair value of leased asset Rs. 7,00,000
Gross Investment = (2,05,803 X 4) + 70,000 = 8,93,212

inception of lease hence it should be classified as finance lease.
Problem No. 10: (May 2015) State any four situations when a lease would be classified as Finance
Lease.
Answer:
Finance Lease is a lease, which transfers substantially all the risks and rewards incidental to
ownership of an asset to the lessee by the lessor but not the legal ownership. As per AS 19, in
following situations, the lease transactions would be classified as Finance lease:
(i) The lessee will get the ownership of leased asset at the end of the lease term.
(ii) The lessee has an option to buy the leased asset at the end of the lease term at price, which is
lower than its expected fair value at the date on which option will be exercised.
(iii) The lease term covers the major part of the life of asset even if title is not transferred.
(iv) At the beginning of lease term, present value of minimum lease rental covers the initial fair
value.
Problem No. 11: (Nov. 2015) Aksat International Limited has given a machinery on lease for 36
months and its useful life is 60 months. Cost & fair market value of the machinery is Rs. 5,00,000.
The amount will he paid in 3 equal annual installments and the lessee will return the machinery to
lessor at termination of lease. The unguaranteed residual value at the end of 3 years is Rs. 50,000.
IRR of investment is 10% and present value of annuity factor of Rs. 1 due at the end of 3 years at
10% IRR is 2.4868 and present value of Rs. 1 due at the end of 3rd year at 10% IRR is 0.7513.
You are required to comment with reason whether the lease constitute finance lease or operating
lease. If it is finance lease, calculate unearned finance income.
Solution:
Annual lease payment is not specified hence same is calculated using IRR. At IRR the present value
of Gross investment in the lease is equal to Fair value of leased asset.
Fair value of leased asset Rs. 5,00,000
Balance is the Present value of 3 annual lease payment (MLP) 4,62,435
Therefore annual lease payment = 4,62,435 / 2.4868 = 1,85,955.85
Gross Investment = (1,85,955.85 X 3) + 50,000 = 6,07,868

63
inception of lease (Rs.4,62,435/ Rs. 5,00,000) x 100 = 92.487%, hence it should be classified as
finance lease.
Problem No. 12: (May 2017) ABC Ltd. took a machine on lease from XYZ Ltd., the fair value being
Rs.10,00,000. The economic life of the machine as well as the lease term is 4 years. At the end of
each year, ABC Ltd. pays Rs.3,50,000. The lessee has guaranteed a residual value of Rs.50,000 on
expiry of the lease to the lessor. However, XYZ Ltd. estimates that the residual value of the
machinery will be Rs.35,000 only. The implicit rate of return is 16% and PV factors at 16% for year 1,
year 2, year 3 and year 4 are 0.8621, 0.7432, 0.6407 and 0.5523 respectively. You are required to
calculate the value of machinery to be considered by ABC Ltd. and the finance charges for each year.
Solution:
Present value of minimum lease payment
Year Lease rental P.V.F. @16% Present Value
1 3,50,000 .8621 3,01,735
2 3,50,000 .7432 2,60,120
3 3,50,000 .6407 2,24,245
4 3,50,000 .5523 1,93,305
Residual Value 50,000 .5523 27,615
10,07,020 (a)
Fair Value 10,00,000 (b)
Lessee will account machinery at lower of the two i.e. at 10,00,000.
Working of Finance Charges:

Year Opening Balance Interest @16% Repayment Closing Balance
1 10,00,000 1,60,000 3,50,000 8,10,000
2 8,10,000 1,29,600 3,50,000 5,89,600
3 5,89,600 94,336 3,50,000 3,33,936
4 3,33,936 53,430 4,00,000 12,634***
***This is rounding off difference and interest of 4 year to be increased to Rs. 66,064.
th
63
Chart
Leases
It includes hire purchases transactions
FINANCE LEASE OPERATING LEASE SALE & LEASE BACK

Basic purpose is sale of asset and
lease is only a mode of financing the Basic purpose is giving asset on Lessee (user) sells the asset to
transaction. (Hence, hire purchases will rent for use lessor & takes it back on lease
also be a finance lease)
NOTE -
Profit or loss is the difference
LESSOR (OWNER) LESSEE (USER) between book value and
LESSOR (OWNER) LESSEE (USER) sale value or reduced sale
Sale of asset and the Purchase of asset and the Owns the asset and Uses the asset
price to be received in price to be paid in instalments value.
claims depreciation and pays the rent Profit or loss in (1), (2), ( 3),
installments over the over the lease term together on it. Lease charges in the form of
lease term together with with interest/ finance charges. (4), (5), (6) & (7)above
are rent income lease rent should be transferred to
interest/finance income Depreciation on asset will be (generally (generally
claimed. P&L a/c immediately.
Lease rental = Recovery accounted on accounted on If loss in 4 above is
of price of asset + Lease rental = Payment of straight line basis) straight line
price of asset + Interest compensated by lower
Interest income Lease rental = basis) lease rental payments then
expense Rent income Lease rental = it should be deferred.
Rent expense In (5), (6) & (7) the excess of
sale value over fair value
will be deferred by debiting
sale value. Hence, sale
value is reduced to fair
Books of Lessee (seller) value and accordingly
profit or loss is calculated.
IF RESULTS INTO FINANCE LEASE IF RESULTS INTO OPERATING LEASE (PARA 50, 52)
Book value of asset 25,000. Sold by A to B for 40,000. ‘B’ Alternatives to explain the position
leased it out to A for 5 years term. Fair value will be taken as ( 1 )( 2 )( 3 )( 4 )( 5 )( 6 )( 7 )Book value25000250002500025000250002500025000Sale
Rs. 40,000. The profit on sale to A Rs. 15,000 will be deferred value30000220002800022000250002800024000Fair
to lease term in proportion to depreciation charged. Same will value30000220003000026000230002600022000Profit 5000- 30003000- 3000- 20001000-3000
happen if there is loss on sale (para 48).
85

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CHAPTER

3.1 Types of leases/Classification of lease:

Leases are classified into

3.3 Operating lease

3.4.1 Risk & Rewards

3.4.2 Substance over form (Indicators of Finance Lease)

Lease term for major part of asset's economic life Yes

Present value of minimum lease payments Yes

Is the lease assets such that it is specialized and

Substance of the agreement is that the significant Yes

Operating Lease Finance Lease

3.4.3 Different classification by lessor and the lessee

3.4.4 Changes in lease classification

(v) Economic life is either:

(vi) Useful life of a leased asset is either:

(x) Unearned finance income is the difference between:

5 Accounting for Leases

Year Discount Minimum lease payments & Present

Year Amount Lease Finance Reduction Closing

Accounting in the books of lessee, assuming that depreciation is charged @20%

End of year 1 Lessor a/c Dr. 5,334

Depreciation a/c Dr. 7,777

End of year 2 Lessor a/c Dr. 5,974

Year 2 Finance lease liability a/c. Dr. 72,291

Year 3 Finance lease liability a/c. Dr. 83,889

Finance lease liability a/c. Dr. 17,000

2nd year Lease rent a/c Dr. 10,000

3rd year Lease rent a/c Dr. 10,000

5.3 Finance Leases in the Financial Statements of Lessors (Owner) (other

Accounting in the books of lessor (owner)

End of year 1 Bank a/c Dr. 10,000

End of year 2 Bank a/c Dr. 10,000

5.3.1 Accounting by manufacturer or dealer lessor

Illustration 11 Account the lease in the books of 'A' ( Manufacturer lessor/owner).

2nd year Bank a/c Dr. 10,000

3rd year Bank a/c Dr. 12,000

2) Gross Minimum lease payment plus NA

5) Depreciation Not applicable Charge as per AS-6

6 Sale and Leaseback Transactions

6.1 Sale and Leaseback Transactions resulting in Finance Lease

Year Payment Finance Reduction in Outstanding

Journal Entries in the books of Seller Lessee

Leased truck a/c. Dr. 60,000

Lease obligation a/c Dr. 9,000

Deferred income a/c. Dr. 2,000

P&L account Dr. 12,000

7 Lease obligation a/c Dr. 10,350

Deferred income a/c. Dr. 2,000

P&L account Dr. 12,000

8 Lease obligation a/c Dr. 11,902

P&L account Dr. 12,000

P&L account Dr. 12,000

6.2 Sale & lease back resulting into operating lease

Gross Investment = (3,71,912 X 3) + 1,00,000 = 12,15,736

Gross Investment = (2,23,147 X 3) + 60,000 = 7,29,441

Calculation of Unearned finance income:

Year Lease Payments Discounting Present Value

Year Discount Minimum lease payments & Present

Gross Investment = (2,05,803 X 4) + 70,000 = 8,93,212

Gross Investment = (1,85,955.85 X 3) + 50,000 = 6,07,868

Working of Finance Charges:

FINANCE LEASE OPERATING LEASE SALE & LEASE BACK

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