Leases is one of the important accounting standard on which detailed improvements /modifications has been made in recent times. Therefore, this article is an attempt to demystify the relevant accounting standard on Leases. My attempt is to present the relevant standards in simple language.
Following are the relevant standards relating with Accounting for leases
1. IND AS 17- Old standard
2. IAS 17-Old standard.
3. INDAS 116-Leases-Inserted by the Companies (Accounting Standards) Amendment Rules 2019 w.e.f 1/4/2019
4. IFRS 16, Leases-Corresponding International Financial Reporting Standard issued by IASB
5. IFRS 16 replaces IAS 17 effective 1 January 2019, with earlier application permitted.
6. AS 19 Leases.
PART I. Old Standards
There isno major differences between INDAS -17 and IAS 17.
Therefore, the following explanations are related with both INDAS 17 and IAS 17.
I. Accounting for leases
It is an arrangement between lessor and lessee through which the lessor gives the right to use an asset for given period of time to lessee on lease rent
To prescribe appropriate accounting policies and disclosure in relation to the lease for the following parties of a lease arrangement.
Applicable in accounting for all leases except :
a. Lease to explore or use minerals , oil ,natural gas & non-regenerative resources
b. Licensing agreement
V. Type of leases
1. Finance Lease
Under the following circumstances,the lease transactions are called Finance lease
1. Owner ship transferred from lessor to lessee at the end of lease
2. Lease can use the bargain purchase option to buy the leased asset at the end of the term
3. When the lease term covers major part of life of asset
4. An arrangement which transfers substantially all risks and rewards incidental to ownership of an asset to the lessee by the lessor
5. when the present value of minimum lease payments greater than or substantially equal to the asset’s fair value
2. Operating Lease
Lease other than Finance lease
VI. Accounting for finance lease -in the books of lessee
A. Following are the important points related with Accounting for finance leases
1. The lessee has to recognize lease as an asset &liability
2. Formula to recognize leased asset
a. Fair value of Asset
b. Present value of minimum lease payments@ interest rate implicit in the lease.
Minimum lease payments(MLP).
For Lessee=Total lease rent to be paid+any guaranteed residual value (by or on behalf of lessee) LESS contingent rent LESS cost or service and tax to be paid by and reimbursed to lessor.
3. Lease payment should be allocated between
a. Finance charges@outstanding liability
b. Reduction of liability
4. The lessee in its books should charge depreciation on finance lease asset as per INDAS -16
5. Initial direct costs of the lessee are added to the amount recognized as an asset
Journal entries in the books of lessee
1. For recording the leased asset
Leased asset A/C Dr
To Lessor’s account
2. To record the initial direct cost
Leased asset A/C Dr
To Bank A/C
3. To record the finance charges
Finance Charges A/C Dr
To Lessor’s account.
4. For period instalment payment of lease
Lesser’s A/C Dr
To bank account
5. For recording depreciation of the leased asset
Depreciation a/c Dr
To Leased assets A/C.
6. To transfer finance charges and depreciation
Profit and loss account Dr
To Finance charges a/c
To depreciation a/c
VII. Accounting for finance lease -in the books of lessor
Following are the important points related with Accounting for finance leases
A. Recognises as receivables at amount equal to net investment
Net Investment = Present value of Gross Investment
Or Gross Investment – Un earned Finance income
Unearned Finance Income = Gross Investment-Present value of Gross Investment
Gross Investment – Net Investment
Gross Investment = Minimum lease payment from lessor point of view + Unguaranteed residual value.
Minimum lease payments(MLP).
For Lessor=Total lease rent to be paid by the lease terms + any guaranteed residual value (by or on behalf of lessee) LESS contingent rent LESS cost for service and tax to be paid by and reimbursed to lessor+residual value guaranteed by third party
B. Recognise finance income based on patterns reflecting a constant period rate of return on lease
C. Journal entries will be as follows.
To record Finnace lease on the date of inception
Lessee(Principal) A/C Dr
Lessee(interest) A/C Dr
To Asset A/C
To Unearned Finance Income
Lease payment received
Bank A/C Dr
To X LtdA/C
To record Finance Income
Unearned Finance Income A/C ..Dr
To Finance Income
VIII.Accounting for operating lease
In the books of lessee
Lease payment shall be recognized as an expense in the statement of profit and loss on a straight -line basis over the lease term
No Asset should be recognized in the financial statement
1. Lease rental due to lessor
Lease rental a/c Dr
2. Payment of lease rental
Lessor A/C Dr
3. Transfer to P/L A/C
Profit or Loss
To lease rental
In the books of lessor
Present asset in balance sheet or statement of financial position
Lease income shall be recognized on straight line basis over lease term unless alternative basis available .
PART II.NEW STANDARDS
INDAS 116-Leases-Inserted by the Companies (Accounting Standards) Amendment Rules 2019 w.e.f 1/4/2019.
I. Objective .
To set out the principles for the—
An entity shall apply this standard to all leases, including leases of right -of-use assets in a sublease,except for :
(a) Lease to explore or use minerals, oil, natural gas and similar non-generative resources.
(b) Leases of biological assets (INDAS 41) held by the lessee
(c) Service concession arrangement within the scope of Appendix D, Service Concession Arrangements, of INDAS 115
(d) Licences of intellectual property granted by the lessor within the scope of INDAS 115
(e) Rights held by a lessee under licensing agreements within the scope of INDAS 38, Intangible assets.
III. Identifying a lease
At the starting of a contract, an entity shall assess whether the contract is or contains, a lease .
Paragraphs B9-B31 of INDAS 116(AppendixB) gives guidance on the assessment of whether a contract is, or contains, a lease.
A lessee shall treat almost all leases, except lease for short-term and leases of low value assets, as finance leases. The following points with respect to lessee are not applicable to lease for short-term and leases of low value assets
At the commencement date, a lessee shall recognize a right-of-use asset and a lease liability.
1. A lessee shall measure the right -of -use asset at cost.
The right -of -use asset at cost shall include the following:-
a. the amount of the initial measurement of the lessee liability.
(The amount of the initial measurement of the lessee liability=present value of the lease payments discounted @interest rate implicit in the lease. If interest rate implicit in the lease cannot be readily determined ,the lessee shall use the lessee’s incremental borrowing rate)
b. any lease payments made at or before the commencement date, less any lease incentives received;
c. any initial direct costs incurred by the lessee
d. an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset and restoring the asset.
2. Initial measurement of the lessee liability.
The amount of the initial measurement of the lessee liability.
The amount of the initial measurement of the lessee liability=present value of the lease payments discounted @interest rate implicit in the lease. If interest rate implicit in the lease cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.
Subsequent measurement of lease Asset (At the balance sheet date)
Subsequent measurement for the right-of-use asset.
The lessee shall measure the right-of -use asset applying a cost model or revaluation model
The lessee shall measure right -of-use asset at cost less depreciation less impairment losses.
At fair value.
Subsequent measurement of lease liability (At the balance sheet date).
Lessee shall measure the lease liability as follows
Add: Interest on the lease liability
Less: Amount of lease payments
Then adjust lease modifications
A lessor shall classify each of its leases as either
a. an operating lease or
b. a finance lease.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset.
A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.
Finance Leases .
Recognition and measurement
A lessor shall recognize assets held under a finance lease in its balance sheet and present them as a receivable at an amount equal to the net investment in the lease.
Subsequent measurement.(At the balance sheet date).
Should recognize finance income over the lease term, based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the lease.
Recognition and measurement
A lessor shall recognize lease payments from operating leases as income on either a straight-line basis or another systematic basis.