PRE AS-19 ERA Prior to 1.04.2001 the “Guidance Note on Accounting for Leases” was applicable on leasing industries. This Guidance Note was based on the matching principle i.e. the periodic costs comprising of depreciation and lease equalization charges were recommended to be matched with lease rentals so that the net income from a finance lease will show a true and fair view. For this Lease Equalization Reserve used to be created. MEANING Lease means transfer of rights to use assets for a specified period of time against the consideration or a series of consideration. Rights to Use Asset Lessee Lessor Consideration OBJECTIVE The objective of this accounting standard is to prescribe for lessees and lessors, the appropriate accounting policies and disclosures in relation to all assets leased that may be finance lease or operating lease. Accounting provided in this AS is based on SUBSTANCE of the transaction rather than on FORM. Exclusions AS-19 does not apply to the followings:- (a) Lease agreement for natural resources such as oil, gas, timber, metals and mineral rights. (b) Licensing agreements for items such as motion picture films, video recordings, patents, manuscripts and copyrights. (c) Lease agreement to use land. (d) Agreements for contracts of services that do not transfer the right to use assets. Example- Use of Taxi FINANCE LEASE A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. If answer to any one of the below is yes then it is a Finance Lease No No • Ownership transferred by the end of lease term • Lease contains bargain purchase option which is so attractive that is reasonably certain that lessee will exercise it. No • Lease term for major part of assets economic life even if title is not transferred No • PV of MLP substantially equals the assets Fair Value as at the date of inception of the lease No • Is the lease assets such that it is specialized and cannot be used by any one else other than lessee without major modification No • Substance of the agreement is that the significant risk and reward of ownership are transferred to the lessee • Operating Lease SOME IMPORTANT DEFINITIONS Minimum lease payments (MLP) MLP from standpoint of Lessee: Minimum Rent + Residual value guaranteed by or on behalf of the lessee. MLP from standpoint of Lessor: Minimum Rent + Residual value guaranteed by or on behalf of the lessee or by an independent party. Matrix for Guaranteed Residual Value in MLP of Lessor / Lessee Situation Whether to include guaranteed Whether to include guaranteed residual value in MLP of Lessor residual value in MLP of Lessee Exclude, since the fee is paid by Any independent third party Include provided the third party the lessor, hence it is clear that guarantees residual value for a is financially capable of meeting the residual value is not fee paid by lessor the guarantee. guaranteed by or on behalf of lessee. Lessee's subsidiary / associate / Include provided the third party Include since the guarantee is on joint venture guarantees residual is financially capable of meeting behalf of lessee. value of leased assets the guarantee. Lessors subsidiary / associates / Since there are not independent joint venture guarantees the Exclude, since it is not on behalf third parties exclude guaranteed residual value of the leased of lessee. residual value from MLP assets Gross Investment in the lease Gross investment= MLP from the standpoint of lessor+ Unguaranteed residual value Unearned Finance Income Gross investment in the Lease - Net investment in the Lease Net Investment in the lease:P V of Gross investment in the Lease It is calculated by discounting the gross investment in the Lease at the interest rate implicit in the lease. Interest rate implicit in the lease (IRR) It is a discount rate which equates Gross Investment in the lease to the fair value of the leased asset. Contingent Rent It is that portion of the lease payments that is not fixed in amount but is based on production or rendering of services. E.g. Percentage of sales. NOTE- MLP from Lessee does not include Contingent Rent. OPERATING LEASE A lease other than a finance lease or where indicators of finance lease do not exist, such type of lease shall be classified as operating lease. INDICATORS OF OPERATING LEASE Short term lease Where lease does not transfer substantially all the risks and rewards incidental to ownership. Where cost of maintenance, taxes and insurance are to incurred by the lessor. Where the lessee is protected against the risk of obsolescence. Accounting treatment for operating lease:From Lessee’s point of view Lease rental paid/payable by lessee should be recognized as an expense on systematic basis. Systematic basis means an expense should be recorded as and when benefits are availed. When systematic basis cannot be identified then straight-line method is used for recording the expenses. From Lessor’s point of view Lease rental received/receivable by lessor should be recognized as an income on systematic basis. If same cannot be identified then straightline method is used for recording the incomes. SALE AND LEASEBACK TRANSACTIONS A sale and leaseback transaction involves the sale of an asset by the vendor and leasing of the same asset back to the vendor. SALE AND LEASEBACK SALE AND FINANCE LEASEBACK CASE I SALE AND OPERATING LEASEBACK CASE II CASE I Whenever SLB is of financial nature, any gain/loss on sale should be deferred and amortized over the lease term in proportion to the depreciation of the leased asset. CASE II Whenever SLB is of operating nature, any profit/loss arising out of sale transaction is recognized immediately when sale price is equal to fair value. • If sale price is above fair valueDeferred income = Sale proceeds – Fair value of asset • If the sale price is below fair 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 amortized in proportion to the lease payments over the period for which the asset is expected to be used. Manufacturer or Dealer lessor The manufacturer or dealer lessor should recognize the transaction of sale in the statement of profit and loss for the period, in accordance with the policy followed by the enterprise for outright sales. If artificially low rates of interest are quoted, profit on sale should be restricted to that which would apply if a commercial rate of interest were charged. ExampleIf customer opts for buying of an asset Cost of an asset ` 1,00,000 Outright Sale ` 1,20,000 Profit ` 20,000 If customer opts for Finance Lease and amount paid after 3 years is ` 1,22,000 Possibility 1Selling price (X) - ` 1,22,000 Possibility 2- ( √ ) Finance income to be recognized at Cost of an asset - ` 1,00,000 commercial rate, say ` 12000,so profit Profit get reduced to `10,000 instead of - ` 22,000 Out of which ` 20,000 is related to 20,000 profit and ` 2,000 is related to finance income. Treatment shown under possibility 1 is not allowed as per AS-19. ` INCOME TAX ISSUES Since Income Tax Act does not recognize the concept of Finance lease, therefore, there will be timing difference and an adjustment for deferred tax will be carried out. However, in case of operating lease accounting treatment is same as per tax laws. Hence ,there is no difference. TREATMENT AS PER TAX LAWS t LEASE RENT Deductible expenditure in the hands of Lessee. •Taxable income in the hands of Lessor. •Lessor will be entitled for depreciation. Treatment as per books in case of FINANCE LEASE LESSEE LESSOR Depreciation and Finance charges are debited to P&L account instead of lease rent. •Finance income is credited to P&L account instead of lease rent. •Lessor will not be entitled for depreciation. DISCLOSURE REQUIREMENTS Disclosures in finance lease by the lessee(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) Contingent rent recognized as an expense in the statement of Profit & loss for the period. (4)The total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date. (5) Lease rentals payable should be shown as follows:PERIOD AMOUNT 0-12 months xxx 12-60 months xxx More than 60 months xxx Disclosures in finance lease by the lessor(1) Unearned Finance Income (2) The unguaranteed residual values accruing to the benefit of the lessor. (3) A general description of the significant leasing arrangements of the lessor. (4) Contingent rent recognized as an income in the statement of Profit & loss for the period. (5) Accounting policy adopted in respect of initial direct costs. (6) The total gross investment in the lease and the present value of minimum Lease payments receivable should be shown as follows:PERIOD AMOUNT 0-12 months xxx 12-60 months xxx More than 60 months xxx Disclosures in operating lease by the lessor(1) Accounting policy adopted in respect of initial direct costs. (2) For each class of assets, the gross carrying amount, the accumulated depreciation and accumulated impairment losses at the balance sheet date. (3) A general description of the significant leasing arrangements. (4) Contingent rent recognized as an income in the statement of Profit & Loss for the period. (5) Lease rentals should be shown as follows:PERIOD AMOUNT 0-12 months xxx 12-60 months xxx More than 60 months xxx Disclosures in operating lease by the lessee(1) A general description of the significant leasing arrangements. (2) The total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date. (3) Lease payments recognized in the statement of Profit & Loss for the period. (4) Lease rentals payable should be shown as follows:- PERIOD AMOUNT 0-12 months xxx 12-60 months xxx More than 60 months xxx