TMI BlogLeasesX X X X Extracts X X X X X X X X Extracts X X X X ..... n 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 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 r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t part of the residual 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transaction between 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 asset ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. The interest rate implicit in the lease is 16 per cent (approx.). This is calculated using the following formula: Img001 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). (b) In the above example, 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. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cated 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.) 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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, Property, Plant and Equipment, 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 under non-cancellable subleases at the balance sheet date; and (f) a general description of the lessee s significant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 return on the net investment of the lessor outstanding in respect of the finance lease. Lease payments relating to the accounting period, excluding costs for services, are reduced from both the principal and the unearned finance income. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h 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 ear . 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 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: (i) not later than one year; (ii) later than one year and not later than five years; (iii) later tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed, an enterprise applies A S 2 8 , Impairment of Assets, 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 10, Property, Plant and Equipment, 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 followin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lished 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 the significant leasing arrangements leads to disclosure of unique or unusual provisions of the agreement or terms of the sale and leaseback transactions. 55. Sale and leaseback transactions may meet the separate disclosure criteria set out in paragraph 12 of Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies. Illustration Sale and Leaseback Tr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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