TMI BlogLeasesX X X X Extracts X X X X X X X X Extracts X X X X ..... gh 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 3. The following terms are used in this Standard with the meanings specified: 3.1 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. 3.2 A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. 3.3 An operating lease is a lease other than a finance lease. 3.4 A non-cancellable lease is a lease that is cancellable only: (a) upon the occurrence of some remote contingency; or (b) with the permission of the lessor; or (c) if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or (d) upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably cer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idual value which is guaranteed by the lessee or by a party on behalf of the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable); and (b) in the case of the lessor, that part of the residual value which is guaranteed by or on behalf of the lessee, or by an independent third party who is financially capable of discharging the obligations under the guarantee. 3.13 Unguaranteed residual value of a leased asset is the amount by which the residual value of the asset exceeds its guaranteed residual value. 3.14 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. 3.15 Unearned finance income is the difference between: (a) the gross investment in the lease; and (b) the present value 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, at the interest rate implicit in the lease. 3.16 Net investment in the lease is the gross inv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a lessor and a lessee is based on a lease agreement common to both parties, it is appropriate to use consistent definitions. The application of these definitions to the differing circumstances of the two parties may sometimes result in the same lease being classified differently by the lessor and the lessee. 8. 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 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 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; (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 ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ₹ 2,35,500. The lease agreement requires the lessee to pay an amount of ₹ 1,00,000 per year beginning December 31, 20X0. The lessee has guaranteed a residual value of ₹ 17,000 on December 31, 20X2 to the lessor. The lessor, however, estimates that the machinery would have a salvage value of only ₹ 3,500 on December 31, 20X2. The interest rate implicit in the lease is 16 per cent (approx.). This is calculated using the following formula: Fair Value = ALR + ALR + .. ALR + RV (1+r) 1 (1+r) 2 (1+r) n (1+r) n Where ALR is annual lease rental, RV is residual value (both guaranteed and unguaranteed), n is the lease term, r is interest rate implicit in the lease. The present value of minimum lease payments from the standpoint of the lessee is ₹ 2,35 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be presented separately in the balance sheet as a current liability or a long-term liability as the case may be. 15. Initial direct costs are often incurred in connection with specific leasing activities, as in negotiating and securing leasing arrangements. The costs identified as directly attributable to activities performed by the lessee for a finance lease are included as part of the amount recognised as an asset under the lease. 16. 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. Example In the example (a) illustrating paragraph 11, the lease payments would be apportioned by the lessee between the finance charge and the reduction of the outstanding liability as follows: Year Finance charge ( Rs .) Payment ( Rs. ) Reduction in outstanding liability ( Rs. ) Outstanding liability ( Rs. ) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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. 22. The lessee should, in addition to the requirements of AS 10, Accounting for Fixed Assets, AS 6, Depreciation Accounting, and the governing statute, 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; (d) contingent rents recognised as expense in the statement of profit and loss for the period; (e) the total of future minimum sublease payments expected to be received ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions imposed by lease arrangements, such as those concerning dividends, additional debt and further leasing. Provided that a Small and Medium Sized Company, as defined in the notification, may not comply with sub-paragraphs (a), (b) and (e). Leases in the Financial Statements of Lessors Finance Leases 26. 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. 27. Under a finance lease substantially all the risks and rewards incident to legal ownership are transferred by the lessor, and 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. 28. 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 in respect of the finance lease. 29. A lessor aims to allocate finance income over the lease term on a systematic and rational basis. This income allocation is based on a pattern reflecting a constant periodic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 35. Manufacturer or dealer lessors sometimes quote artificially low rates of interest in order to attract customers. The use of such a rate would result in an excessive portion of the total income from the transaction being recognised at the time of sale. If artificially low rates of interest are quoted, selling profit would be restricted to that which would apply if a commercial rate of interest were charged. 36. 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. 37. The lessor should make the following disclosures for finance leases: (a) a reconciliation between the total gross investment in the lease at the balance sheet date, and the present value of minimum lease payments receivable at the balance sheet date. In addition, an enterprise should ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ciation 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. 44. To determine whether a leased asset has become impaired, an enterprise applies the Accounting Standard dealing with impairment of assets [4] 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. 45. 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. 46. 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 st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure lease payments at below market price, it should be deferred and amortised in proportion to the lease payments over the period for which the asset is expected to be used. If the sale price is above fair value, the excess over fair value should be deferred and amortised over the period for which the asset is expected to be used. 51. If the leaseback is an operating lease, and the lease payments and the sale price are established at fair value, there has in effect been a normal sale transaction and any profit or loss is recognised immediately. 52. For operating leases, if the fair value at the time of a sale and leaseback transaction is less than the carrying amount of the asset, a loss equal to the amount of the difference between the carrying amount and fair value should be recognised immediately. 53. For finance leases, no such adjustment is necessary unless there has been an impairment in value, in which case the carrying amount is reduced to recoverable amount in accordance with the Accounting Standard dealing with impairment of assets. 54. Disclosure requirements for lessees and lessors apply equally to sale and leaseback transactions. The required description of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Note 1.- These parts of the table represent circumstances that would have been dealt with under paragraph 52 of the Standard. Paragraph 52 requires the carrying amount of an asset to be written down to fair value where it is subject to a sale and leaseback. Note 2.- The profit would be the difference between fair value and sale price as the carrying amount would have been written down to fair value in accordance with paragraph 52. ----------------------------------------- Notes:- [1] In respect of assets leased prior to the effective date of the notification prescribing this Standard under section 211 of the Companies Act, 1956, the applicability of this Standard would be determined on the basis of the Accounting Standard (AS) 19, issued by the ICAI in 2001. [2] The difference between this figure and guaranteed residual value (Rs.17,000) is due to approximation in computing the interest rate implicit in the lease. [3] Accounting Standard (AS) 28, Impairment of Assets , specifies the requirements relating to impairment of assets. [4] Accounting Standard (AS) 28, Impairment of Assets , specifies the requirements rela ..... X X X X Extracts X X X X X X X X Extracts X X X X
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