AS 19 – Leases

Applicability

This statement will come into force in respect of all assets leased during the accounting period commencing on or after 1-4-2001 and is mandatory in nature.

The statement will be applied in accounting for all leases other than:

• lease agreements to explore for or use natural resources, such as oil, gas, timber, metals and other mineral rights; and
• licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights; and
• lease agreements to use lands.

The statement will apply to agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. However this statement will 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.

This statement is not applicable to hire purchase agreements.

Objective: to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure in relation to finance leases and operating leases.

Definitions

• 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.
• Finance Lease is a lease that transfers substantially the entire risks and rewards incident to ownership of an asset.
• Operating Lease is a lease other than a finance lease.
• Fair Value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction.
• Economic Life is either:
1. the period over which an asset is expected to be economically usable by one or more users; or
2. the number of production or similar units expected to be obtained from the asset by one or more uers.
• Useful Life of a leased asset is either:
1. the period over which the leased asset is expected to be used by the lessee; or
2. the number of production or similar units expected to be obtained from the use of the asset by the lessee.

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:

1. the lease transfers ownership of the asset to the lessee by the end of the lease term;
2. 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;
3. the lease term is for the major part of the economic life of the asset even if title is not transferred;
4. 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
5. the leased asset is of a specialized nature such that only the lessee can use it without major modifications being made.

In respect of following situations, which individually or in combination could also lead to a lease being classified as a finance lease:

1. if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;
2. gains or losses from the fluctuation in the fair value of the residual fall to the lessee (for example in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and
3. the lessee can continue the lease for a secondary period at a rent which is substantially lower than market rent.

Treatment in the books of Lessee

Finance Lease

The lessee shall recognize the lease, as an asset and a corresponding liability, will be created. The asset and liability will be at an amount equal to the fair value of the leased assets at the inception of the lease. However, if the fair value of the leased asset exceeds the present value of the minimum lease payments from the standpoint of the lessee, the amount recorded as an asset and a liability should be the present value of the minimum lease payments from the standpoint of the lessee.

Transactions and other events are accounted for and presented in accordance with their substance and financial reality and not merely with their legal form.

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.

Lease payment 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.

A finance lease gives rise to a depreciation expenses for the asset as well as a finance expense for each accounting period. The depreciation policy for a leased asset should be consistent with that for depreciable assets which are owned, and the depreciation recognised should be calculated on the basis set out in Accounting Standard (AS) 6, Depreciation Accounting. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the lease term or its useful life, whichever is shorter.

Operating Lease

Lease payments under an operating lease should be recognised as an expense in the statement of profit and loss on a straight line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit, even if the payments are not on that basis.

Treatment of in the books of the Lessor

Finance Lease

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.

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.

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.

In the books of the lessor the lease asset is classified as recoverable and hence depreciation will not be provided. Even though the lessor is the legal owner of the asset having used the assets in the course of its leasing business no depreciation will be provided in the books of account. However the depreciation may be claimed under section 32 of the Income-tax Act, 1961 on the leased asset.

Operating Lease

Lease income from operating leases should be recognised in the statement of profit and loss on a straight line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is diminished.

Costs, including depreciation, incurred in earning the lease income are recognised as an expense. Lease income (excluding receipts for services provided such as insurance and maintenance) is recognised in the statement of profit and loss on a straight line basis over the lease term even if the receipts are not on such a basis, unless another systematic basis is more representative of the time pattern in which benefit derived from the use of the leased asset is diminished.

Initial direct costs, incurred specifically to earn revenues from an operating lease are either deferred 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.

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.

Sale and Lease Back Transaction

A sale and lease back 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. The accounting treatment of a sale and lease back transaction depends upon the type of lease involved.

If a sale and lease back transaction results in a finance lease, any excess or deficiency of sales proceeds over the carrying amount should not be immediately recognized 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.

If the lease back is a finance lease, it is not appropriate to regard an excess of sales proceeds over the carrying amount as income. Such excess is deferred and amortised over the lease term in proportion to the depreciation to the depreciation of the leased asset. Similarly, it is not appropriate to regard a deficiency as loss. Such deficiency is deferred and amortised over the lease term.

If a sale and lease back transaction results in an operating lease, and it is clear that the transaction is established at fair value, any profit or loss should be recognized immediately. If the sale price is below 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 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.

If the lease back 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.

For operating leases, if the fair value at the time of a sale and lease back 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.

Disclosures for Finance Lease:

The Lessee should, in addition to the requirements of AS 10 - Accounting for Fixed Assets; AS 6 - Depreciation Accounting and any governing statues, make the following disclosures:

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. 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:
1. not later than one year,
2. later than one year and not later than five years,
3. later than five years.
4. Contingent rents recognised as income in the statement of profit and loss for the period.
5. The total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date.
6. A general description of the lessee’s significant leasing arrangements including, but not limited to, the following:
1. the basis on which contingent rent payments are determined,
2. the existence and terms of renewal or purchase options and escalation clauses, and
3. restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.

The Lessor should make the following disclosures:

1. 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:
1. not later than one year,
2. later than one year and not later than five years,
3. later than five years,
2. Unearned finance income.
3. The unguaranteed residual values accruing to the benefit of the lessor.
4. The accumulated provision for uncollectible minimum lease payments receivable.
5. Contingent rents recognised in the statement of profit and loss for the period.
6. A general description of the significant leasing arrangements of the lessor.
7. Accounting policy adopted in respect of initial direct costs.

Disclosures for Operating Lease

The Lessee should make the following disclosures for the operating leases:

1. The total of future minimum lease payments under non-cancellable operating leases for each of the following periods:
1. not later than one year,
2. later than one year and not later than five years,
3. later than five years.
2. The total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date.
3. Lease payments recognised in the statement of profit and loss for the period, with separate amounts for minimum lease payments and contingent rents.
4. Sub-lease payments received (or receivable) recognised in the statement of profit and loss for the period.
5. A general description of the lessee’s significant leasing arrangements including, but not limited to, the following:
1. the basis on which contingent rent payments are determined,
2. the existence and terms of renewal or purchase options and escalation clauses, and
3. restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.

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 disclosure for operating leases:

1. For each class of assets:
1. the gross carrying amount,
2. the accumulated depreciation, and
3. accumulated impairment losses at the balance sheet date.
2. The depreciation recognised in the statement of profit and loss for the period.
3. Impairment losses recognised in the statement of profit and loss for the period.
4. Impairment losses reversed in the statement of profit and loss for the period.
5. The future minimum lease payments under non-cancellable operating leases in the aggregate and for each of the following periods:
1. not later than one year,
2. later than one year and not later than five years,
3. later than five years.
6. Total contingent rents recognised in the statement of profit and loss for the period.
7. A general description of the significant leasing arrangements of the lessor.
8. Accounting policy adopted in respect of initial direct costs.