Presentation ByCA Rajeev Sogani Date : 3rd Dec,2011

PRE AS-19 ERA

Prior to 1.04.2001 the Guidance Note on Accounting for Leases

was applicable on leasing industries. This Guidance Note was

based on the matching principle i.e. the periodic costs comprising of depreciation and lease equalization charges were

recommended to be matched with lease rentals so that the net

income from a finance lease will show a true and fair view. For this Lease Equalization Reserve used to be created.

CA RAJEEV SOGANI

3rd December,2011

MEANING
Lease means transfer of rights to use assets for a specified period of time against the consideration or a series of consideration.

Rights to Use Asset Lessee Lessor

Consideration

CA RAJEEV SOGANI

3rd December,2011

OBJECTIVE
The objective of this accounting standard is to prescribe for lessees and lessors, the appropriate accounting policies and disclosures in relation to all assets leased that may be finance lease or operating lease.

Accounting provided in this AS is based on SUBSTANCE of

the transaction rather than on FORM.

CA RAJEEV SOGANI

3rd December,2011

EXCLUSIONS
AS-19 does not apply to the followings:-

(a) Lease agreement for natural resources such as oil, gas,

timber, metals and mineral rights. (b) Licensing agreements for items such as motion picture films, video recordings, patents, manuscripts and copyrights. (c) Lease agreement to use land. (d) Agreements for contracts for services that do not transfer the right to use assets. Example- Use of Taxi
CA RAJEEV SOGANI 3rd December,2011

FINANCE LEASE
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset.

INDICATORS OF FINANCE LEASE

Transfer of ownership at the end of lease term.

Where lessee has purchased the option at very reduced rates and lessee is
certain to opt for this purchase option at the inception. Where lease term covers substantial period of economic life of the asset. Where amount paid as lease rentals in terms of P.V. is equal to the fair value of the asset. Where asset is of specialized nature and cannot be used by person other than lessee without making major modifications.

CA RAJEEV SOGANI

3rd December,2011

INDICATORS OF FINANCE LEASE

Long term lease Where lease transfers substantially all the risks and rewards incidental to ownership. Title may or may not eventually be transferred. Where lease cannot be cancelled or can be cancelled only if the lessor is reimbursed for any losses. Where lessee is required to take the risk of obsolescence. Where cost of maintenance, taxes and insurance are to be incurred by the lessee unless the contract so provide for.

CA RAJEEV SOGANI

3rd December,2011

SOME IMPORTANT DEFINITIONS

Minimum lease payments
MLP from standpoint of Lessee= Minimum Rent + Residual value guaranteed by or on behalf of the lessee. MLP from standpoint of Lessor= Minimum Rent + Residual value guaranteed by or on behalf of the lessee or by an independent party.

Gross Investment in the lease Gross investment= MLP from the standpoint of lessor+ Unguaranteed residual value

Unearned Finance Income

Gross investment in the lease Less: P.V. of MLP from the standpoint of Lessor Less: P.V. of unguaranteed residual value

CA RAJEEV SOGANI

3rd December,2011

Net Investment in the lease:Gross Investment in the lease Unearned Finance Income

Interest rate implicit in the lease (IRR) It is a discount rate which equates Gross Investment in the lease to the fair value of the leased asset.

Contingent Rent It is that portion of the lease payments that is not fixed in amount but is based on production or rendering of services. E.g. Percentage of sales. NOTE- MLP from Lessee does not include Contingent Rent.

CA RAJEEV SOGANI

3rd December,2011

ACCOUNTING TREATMENT IN CASE OF FINANCE LEASE

This can be explained with the help of an illustrationFair value of the machinery `2,35,500 Lease Term 3 years Lease Rent `1,00,000 Guaranteed Residual Value by lessee ` 17000 Implicit Rate of Interest 16% p.a. Method of Depreciation SLM
The amount of depreciation charged is equal to ` 72,833

(2,35,500-17,000/3)

CA RAJEEV SOGANI

3rd December,2011

In the books of lessorThe asset given under a finance lease is recognized as a receivable at an
amount equal to the net investment in the lease.
Amount in ` Year Lease receivable 2,35,500 1,73,180 1,00,890 Installment Finance Income Principal (Lease receivable x 16%) 37,680 27,710 16,140 Balance Sheet 62,320 72,290 83,860 Closing Balance 1,73,180 1,00,890 17,030

1 2 3

1,00,000 1,00,000 1,00,000

Profit & Loss Account

Year 1 Year 2 Year 3

By Finance income 37,680 Asset (Year 1) By Finance income 27,710 Lease Rent Receivable 2,35,500 By Finance income 16,140 (-)Lease rent received 62,320 1,73,180
3rd December,2011

CA RAJEEV SOGANI

In the books of lesseeThe asset taken on lease is recognized at an amount which would be lower of fair value or P.V. of MLP from standpoint of lessee.
(Amount in `) Year Lease Rental payable 2,35,500 Installment Finance Repayment of charges liability (Lease rental payable x 16%) 37,680 62,320 Closing balance

1,00,000

1,73,180

2
3

1,73,180
1,00,890

1,00,000
1,00,000

27,710
16,140

72,290
83,860 (Amount in `) Total 1,10,513 1,00,543 88,974 3,00,030 72,833 72,833

1,00,890
17,030

Charge in Profit and Loss Year 1 2 3 Finance Charges 37,680 27,710 16,140 GRAND TOTAL CA RAJEEV SOGANI Depreciation

72,834

3rd December,2011

Balance Sheet

Liability

Asset

1st year O/s Liability 2,35,500 Machinery 2,35,500 (-) Repayment of Liab. 62,320 1,73,180 (-)Depreciation 72,833 1,62,667

2nd year O/s Liability 1,73,180 Machinery 1,62,667 (-) Repayment of Liab. 72,290 1,00,890 (-)Depreciation 72,833 89,834
3rd year O/s Liability 1,00,890 Machinery 89,834 (-) Repayment of Liab. 83,860 17,030 (-)Depreciation 72,834

17,000

CA RAJEEV SOGANI

3rd December,2011

OPERATING LEASE
A lease other than a finance lease or where indicators of finance lease do not exist, such type of lease shall be classified as operating

lease.
INDICATORS OF OPERATING LEASE
Short term lease Where lease does not transfer substantially all the risks and

rewards incidental to ownership.

Where cost of maintenance, taxes and insurance are to incurred

by the lessor.
Where the lessee is protected against the risk of obsolescence.
CA RAJEEV SOGANI 3rd December,2011

Accounting treatment for operating lease:From Lessees point of view

Lease rental paid/payable by lessee should be recognized as an expense

on systematic basis.
Systematic basis means an expense should be recorded as and when

benefits are availed. When systematic basis cannot be identified then

straight-line method is used for recording the expenses.

From Lessors point of view

Lease rental received/receivable by lessor should be recognized as an

income on systematic basis. If same cannot be identified then straightline method is used for recording the incomes.
CA RAJEEV SOGANI 3rd December,2011

SALE AND LEASEBACK TRANSACTIONS

A sale and leaseback transaction involves the sale of an asset by the vendor and leasing of the same asset back to the vendor.
SALE AND LEASEBACK

SALE AND FINANCE LEASEBACK

SALE AND OPERATING LEASEBACK

CASE I

CASE II

CA RAJEEV SOGANI

3rd December,2011

CASE I
Whenever SLB is of financial nature, any gain/loss on sale should be deferred and amortized over the lease term in proportion to the depreciation of the leased asset. CASE II Whenever SLB is of operating nature, any profit/loss arising out of sale transaction is recognized immediately when sale price is equal to fair value.

CA RAJEEV SOGANI

3rd December,2011

 If sale price is above fair valueDeferred income = Sale proceeds Fair value of asset

If the sale price is below fair value, any profit or loss should be recognized immediately except that, if the loss is compensated

by future lease payments at below market price, it should be

deferred and amortized in proportion to the lease payments over the period for which the asset is expected to be used.

CA RAJEEV SOGANI

3rd December,2011

BOOT CONTRACTS
BOOT (Build, Own, Operate, Transfer) Contracts are executed with the

Government which involves private sector entity constructing the infrastructure facility on the land owned by the government and operating and maintaining that infrastructure for specified period usually 20 to 25 years. This period is referred to as the Concession Period after which ownership is transferred to the government.
BOOT transactions are outside the purview of finance lease because of

the following reasons It does not cover the majority of the useful life of the asset. The element of ownership is totally missing in the contract. Major portion of expenditure is incurred by the lessee. Therefore, such

transactions do not qualify for Finance Lease.

CA RAJEEV SOGANI 3rd December,2011

Manufacturer or Dealer lessor

The manufacturer or dealer lessor should recognize the transaction

of sale in the statement of profit and loss for the period, in accordance with the policy followed by the enterprise 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. ExampleIf customer opts for buying of an asset Cost of an asset Outright Sale Profit ` 1,00,000 ` 1,20,000 ` 20,000

CA RAJEEV SOGANI

3rd December,2011

If customer opts for Finance Lease and amount paid after 3 years is
` 1,22,000 Possibility 1Selling price (X) - ` 1,22,000 Possibility 2- ( ) Finance income to be recognized at commercial rate, say ` 12000,so profit get reduced to `10,000 instead of `

Cost of an asset - ` 1,00,000 Profit - ` 22,000

Out of which ` 20,000 is related to

profit and ` 2,000 is related to finance income.

20,000

Treatment shown under possibility 1 is not allowed as per AS-19.

CA RAJEEV SOGANI

3rd December,2011

INCOME TAX ISSUES

Since Income Tax Act does not recognize the concept of Finance lease, therefore, there will be timing difference and an adjustment for deferred tax will be carried out. However, in case of operating lease accounting treatment is same as per tax

laws. Hence ,there is no difference.

TREATMENT AS PER TAX LAWS

t
LEASE RENT

Deductible expenditure in the hands of Lessee.

Taxable income in the hands of Lessor. Lessor will be entitled for depreciation.

CA RAJEEV SOGANI

3rd December,2011

Treatment as per books in case of FINANCE LEASE

LESSEE LESSOR

Depreciation and Finance charges are debited to P&L account instead of lease rent.

Finance income is credited to P&L account instead of lease rent. Lessor will not be entitled for depreciation.

CA RAJEEV SOGANI

3rd December,2011

DISCLOSURE REQUIREMENTS
Disclosures in finance lease by the lessee(1) Assets acquired under finance lease as segregated from the assets owned. (2) For each class of assets, the net carrying amount at the balance sheet date. (3) Contingent rent recognized as an expense in the statement of Profit & loss for the period. (4)The total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date. (5) Lease rentals payable should be shown as follows:PERIOD AMOUNT

0-12 months
12-60 months More than 60 months

xxx
xxx xxx

CA RAJEEV SOGANI

3rd December,2011

Disclosures in finance lease by the lessor-

(1) Unearned Finance Income (2) The unguaranteed residual values accruing to the benefit of the lessor. (3) A general description of the significant leasing arrangements of the lessor. (4) Contingent rent recognized as an income in the statement of Profit
& loss for the period. (5) Accounting policy adopted in respect of initial direct costs. (6) The total gross investment in the lease and the present value of minimum Lease payments receivable should be shown as follows:PERIOD AMOUNT

0-12 months
12-60 months More than 60 months

xxx
xxx xxx

CA RAJEEV SOGANI

3rd December,2011

Disclosures in operating lease by the lessor(1) Accounting policy adopted in respect of initial direct costs.
(2) For each class of assets, the gross carrying amount, the accumulated depreciation and accumulated impairment losses at the balance sheet date. (3) A general description of the significant leasing arrangements. (4) Contingent rent recognized as an income in the statement of Profit & Loss for the period. (5) Lease rentals should be shown as follows:PERIOD AMOUNT

0-12 months
12-60 months More than 60 months CA RAJEEV SOGANI

xxx
xxx xxx 3rd December,2011

Disclosures in operating lease by the lessee(1) A general description of the significant leasing arrangements.
(2) The total of future minimum sublease payments expected to be received

under non-cancellable subleases at the balance sheet date.

(3) Lease payments recognized in the statement of Profit & Loss for the period. (4) Lease rentals payable should be shown as follows:-

PERIOD
0-12 months 12-60 months More than 60 months

AMOUNT
xxx xxx xxx

CA RAJEEV SOGANI

3rd December,2011

CA RAJEEV SOGANI

3 rd December,2011 28