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.

Lease word cloud

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

II. Lease

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

III. Objective

To prescribe appropriate accounting policies and disclosure in relation to the lease for the following parties of a lease arrangement.

a. Lessor

b. Lessee

IV. Scope

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

Minimum of

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

Or

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

Journal

1. Lease rental due to lessor

Lease rental a/c Dr

To lessor

2. Payment of lease rental

Lessor A/C Dr

To Cash

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—

a. recognition

b. measurement

c. presentation

d. disclosure

of leases

II. Scope

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.

IV. Lessee.

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

Recognition.

At the commencement date, a lessee shall recognize a right-of-use asset and a lease liability.

Measurement .

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

Cost model

 The lessee shall measure right -of-use asset at cost less depreciation less impairment losses.

Revaluation Model.

At fair value.

Subsequent measurement of lease liability (At the balance sheet date).

Lessee shall measure the lease liability as follows

Carrying Amount

Add: Interest on the lease liability

Less: Amount of lease payments

Then adjust lease modifications

IV. Lessor

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.

Operating Leases

Recognition and measurement

A lessor shall recognize lease payments from operating leases as income on either a straight-line basis or another systematic basis.

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2 Comments

  1. NehaKey says:

    Thanks for the insightful article Mr. Sivakumar. The concepts are explained well and are very easy to understand. Looking forward to reading more and learning more.

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