Commerce

Lease Accounting

Posted by Asok K Nadhani on

Lease

Lease is an agreement whereby the lessor conveys to the lessee the right to use an asset for an agreed period of time in return for a payment or series of payments (AS-19).

Leasing provides the lessee with the assets services without incurring either the equity investment or any debt obligation. Leasing, therefore, is considered to be a source of financing that enables a firm to avail the services of a desired asset.

AS-19 does not cover lease agreement to use lands, items like motion picture films, explore and use of natural resources and licensing of copyrights, patents etc.

The assets given on lease basis can be plant, machinery, computer, car, industrial unit or similar items.

Types of Leases : For Accounting purpose, leases are classified as:

  • Finance Lease : In this type of lease all the risks and rewards incident to ownership of an asset are substantially transferred.
  • The asset is irrevocably leased out by the lessor to the lessee for nearly the whole useful life of the asset. During the lease term, the lessor can recover his capital outlay plus a return on his investment in the asset. Actually the lessor plays the role of the financier or the asset. Aircraft, rail, cars, land, building, heavy machines, diesel generating sets, etc. are these types of leased assets.
  • Operating Lease : In this type of lease all the risks and rewards incident to ownership of an asset are substantially not transferred.
  • The primary lease period is mostly inadequate for the lessee to recover his investment in the asset to the full extent. Here the lessee enjoys the right of cancellation; the lessor runs the risk of obsolescence of the asset. Computers, office equipment, automobiles, trucks etc. are these types of leased assets.
  • Non-Cancelable Lease : As per AS-19, non-cancelable lease is a lease that is cancelable only:
  • Upon the occurrence of some remote contingency; or with the permission of the lessor;
  • If the lessee enters into a new lease for the same or an equivalent asset with the same lessor;
  • Upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably certain.
  • Leveraged Lease : A finance lease or an operating lease becomes a leveraged lease if in the lease contract, apart from a lessor and lessee there is a long-term lender also. In a leveraged lease, the lessor finances only a small part of the investment involved in the lease and the major portion of the finance is provided by the long-term lender.

Leveraged lease is used by the lessor when huge capital investment is required to acquire services of a long-term lender.

Lease Accounting Terms

  • Inception of the lease: It is the earlier of the date of the lease agreement and the date of a commitment by the parties to the principal provisions of the lease.
  • Lease Term: It is the non-cancellable period for which the lessee has agreed to take on lease the asset together with any further periods for which the lessee has the option to continue the lease of the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise.
  • Minimum Lease Payments: These are the lease payments over the lease term that the lessee is (or can be required) to make (excluding contingent rent & costs) for services and taxes to be paid by and reimbursed to the lessor, together with:
  • in the case of the lease, any residual value guaranteed by or on behalf of the lessee; or
  • in the case of the lessor, any residual value guaranteed to the lessor:
    • by or on behalf of the lessor; or
    • by an independent third party financially capable of meeting this guarantee.

However, if the lessee has an option to purchase the asset at a price expected to be sufficiently lower than the fair value at the date the option becomes exercisable that, at the inception of the lease, is reasonably certain to be exercised, the minimum lease payments comprise minimum payments payable over the lease term and the payment required to exercise this purchase option.

  • Contingent Rent: It is that portion of the lease payments that is not fixed in amount but is based on a factor other than just the passage of time (e.g., percentage of sales, amount of usage, price indices, market rate of interest).
  • Economic Life: It may be either
  • the period over which the asset is expected to be economically usable by one or more users
  • the number of production or similar units expected to be obtained from the asset by one or more users.
  • Useful Life: It may be either
  • the period over which the leased asset is expected to be used by the lessee; or
  • the number of production or similar units expected to be obtained from the use of the asset by the lessee.
  • Residual Value: The estimated fair value of the leased asset at the end of the lease term.
    • Guaranteed Residual Value:
  • In case of lessee, it refers to that 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);
  • In case of lessor, it refers to 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.
  • Unguaranteed Residual Value: The amount by which the residual value of the asset exceeds its guaranteed residual value.
  • Gross Investment in the Lease: It 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.
  • Unearned Finance Income: It is the difference between
  • the gross investment in the lease; and
  • the present value of:
    • the minimum lease payments under a finance lease from the standpoint of the lessor, and
    • any unguaranteed residual value accruing to the lessor, at the interest rate implicit in the lease.
  • Net Investment in the Lease: The gross investment in the lease less unearned finance income.
  • Interest Rate Implicit in the Lease: It is the discount rate that, at the inception of the lease, causes the aggregate present value of the following to be equal to the fair value of the leased assets.
  • the minimum lease payments under a finance lease from the standpoint of the lessor; and
  • any Unguaranteed residual value accruing to the lessor,

Interest rate implicit
Ex. Arindam leased a plant to Aritra on 1.1.05. Fair value of Plant was Rs.2,40,000. Implicit rate of interest was 15% p.a. Annual lease rent payable was Rs.1,00,000 commencing from 31.12.05 for three years. Arindam (Lessor) estimated the salvage value of Machine as Rs.19,000 at the end of third year. However, Aritra (Lessee) guaranteed only Rs.7,000 as residual value.

Calculate minimum lease payment and value of the asset to be recognised in the books of lessee. Present value factors @ 15% for 3 years are: year 1– 0.870, year 2– 0.756, year 3- 0.658.

Solution:

1.     Minimum Lease Payment: As per AS – 19, Minimum lease payment is the amount that lessee is required to pay over the lease term together with guaranteed residual value. Therefore, in the Illustration, minimum lease payment will be:

 Lease Rent (Rs.)
Year 1  1, 00,000
Year 2  1,00,000
Year 31, 00,000
 3, 00,000
Add: Guaranteed Residual Value             7,000
        3, 07,000
  • Recognition of Asset in the books of Lessee: As per AS – 19, asset should be recognized at the fair value at the inception of lease. However, if the fair value exceeds the present value of minimum lease payment, asset should be recognised at the present value of minimum lease payment. In the given example, present value of minimum lease payment will be as under:
YearLease RentP/V factor @ 15%P/V s
11,00,0000.87087,000
21,00,0000.75675,600
31,00,0000.65865,800
47,000 (Guaranteed Salvage value)0.6584,606
 P/V of minimum lease payments                                                               2,33,006

Since, fair value of plant of Rs.2,40,000 is more than the present value of minimum lease payment (Rs.2,33,006), Plant will be recognised at Rs.2,33,006 in the books of lessee.

Finance Leases

Books of the Lessee

  • The fair value of the asset or the present value of lease payments, whichever is less, should be recognised as an asset with a corresponding liability.

The discounting rate is the rate at which the annual lease rental along with the residual value of the asset discounted comes to the fair value of the asset at the time of inception.

  • Directly attributed cost of acquiring the asset under lease shall also be capitalized.
    • The annual lease payment shall be allocated into the financial charge i.e. the interest portion and also the principal repayment. The financial charge will be charged to the profit and loss account and the portion of principal amount paid shall be deducted from the liability.
    • The lessee shall also charge the depreciation to the profit and loss account as he is the practical user of the asset and responsible for the risks and rewards associated with the asset.
    • The leased asset should be disclosed separately and the reconciliation statement on the lease payments should be prepared in a way to show the position upto one year, one to five years and later than five years.
    • Disclosures by Lessee:

All disclosure required as per AS – 6, AS – 10 and under any applicable statute.

  1. Assets acquired under finance lease as segregated from the assets owned;
  2. The net carrying amount at the balance sheet date for each class of assets;
  3. Contingent rents recognised as expense in the statement of profit and loss for the period
  4. 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;
    1. The existence and terms of renewal or purchase options and escalation clauses; and
    1. Restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.
      1. Level I companies should also disclose the following
  5. Reconciliation between the total of minimum lease payments at the balance sheet date and their present value. The total of minimum lease payments at the balance sheet date, and their present value, should also be disclosed for each of the following periods:
    1. not later than one year;
    1. later than one year and not later than five years;
    1. later than five years;
  6. The total of future minimum sublease payments expected to be received under non-cancelable subleases at the balance sheet date

Books of the Lessor

  • The lessor shall recognize the asset at the net lease payments receivable amount.
  • The lessor shall determine the finance income in such a manner so as to reflect the constant periodic rate of return on the net investment outstanding in respect of finance lease and shall recognize the income statement.
  • The initial costs to materialize the lease incurred by the lessor shall be charged to profit and loss account (incurred to earn the rewards and returns on the lease of the asset).
  • The transaction shall be regarded as on outright sale by the lessor and the sale value be the fair value of the asset or the present value of lease payments, whichever is lower. The cost of sale shall be the carrying amount of the asset.
  • Disclosures by Lessor: The lessor should make the following disclosures for finance leases:
  • Unearned finance income;
  • The unguaranteed residual values accruing to the benefit of the lessor;
  • The accumulated provision for uncollectible minimum lease payments receivable;
  • Contingent rents recognized in the statement of profit and loss for the period;
  • Level 1 enterprise should also disclose the following:
    • 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. The enterprise should also 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:
  • not later than one year;
  • later than one year and not later than five years;
  • later than five years;
    • A general description of the significant leasing arrangements of the lessor;
    • Accounting policy adopted in respect of initial direct costs.

As an indicator of growth, it is often useful to also disclose the gross investment less unearned income in new business added during the accounting period, after deducting the relevant amounts for cancelled leases.

Accounting of Finance Leases : Asset given under lease should be shown in balance sheet as receivable at an amount equal to the ‘net investment’ in the lease (Investment less unearned finance income).

  • Finance Income: This income allocation is based on a pattern of a constant periodic return on the net investment outstanding and should be recognized in Profit and loss Account.
  • Unguaranteed Residual Value: Income allocation over the remaining lease term will be revised. Upward adjustment of the estimated residual value is not made.
  • Direct Costs: Expenses directly related to the lease (e.g. commission, legal fees, etc.) should be debited in Profit and Loss Account immediately or allocated against the finance income over the lease term.

Accounting Entries of Finance Leases

In the Books of Lessee

1. On entries into contract:      Asset A/c                                                         Dr.
To Obligation (Lessor’s) A/c 
    (Rental assets recorded at fair value) 
If first payment is made in the beginning of yr. 1     Rental Obligation (Lessor’s) A/c To Bank A/c     (First instalment paid on commencement of lease)  Dr.
3. When finance charge becomes payable at the end of year 1     Finance Charge A/c To Finance Charge Payable A/c    (Finance charge due at the end of year 1)  Dr.
4. When payment is made Rental Obligation A/c    Finance Charge Payable A/c                               To Bank A/c    (Payment of lease rent including finance charge)  Dr. Dr.
5. When depreciation is charged     Depreciation A/c        To Asset A/c     (Depreciation charged)  Dr.
6. When additional payments for maintenance, insurance etc. are incurred (such entries will be repeated in subsequent years.) Maintenance A/c Insurance A/c         To Bank A/c    (Maintenance and insurance charges paid)    Dr. Dr.
Guaranteed salvage when value is paid at the termination of lease     Rental Obligation A/c To Bank A/c     (Asset purchased by paying guaranteed amount)  Dr.
When salvage value is sold out     Bank A/c      To Asset A/c     (Salvage of asset sold)  Dr.

In the Books of Lessor

1. When on signing of contract asset is leased      Rent Receivable A/c (Lessee’s) A/c To Assets A/c      (Asset leased out at net investment value)  Dr.
2. When leased installments is received in the beginning of year 1      Bank A/c                                                        Dr.            To Rent Receivable (Lessee’s) A/c      (First instalment received on commencement of lease)  Dr.
3. When finance charge becomes receivable at the end of year 1      Finance Income Receivable A/c To Finance Income A/c      (Finance charge due from lessee at the end of year 1)  Dr.
4. When payment from lessee is received (such entries will be repeated in subsequent years.)      Bank A/c          To Rent Receivable or Lessee’s A/c To Finance Income Receivable      (Lease instalment, including finance income received at the end of first year)    Dr.
5. End of Lease period when asset is sold to lessee       Bank A/c          To Rent Receivable A/c or Lessee’s A/c       (Guaranteed salvage value received from lessee)  Dr.

Operating Leases

Books of the Lessee

  • Lease payments under an operating lease should be recognised as an expense.
  • Disclosures by Lessee :
  • Lease payments recognized in the statement of profit and loss for the period, with separate amounts for minimum lease payments and contingent rents;
  • Sub-lease payments received (or receivable) recognized in the statement of profit and loss for the period;
  • Level 1 enterprise should also disclose the following:
    • the total of future minimum lease payments under non-cancelable operating leases for each of the following periods:
  • Not later than one year;
  • Later than one year and not later than five years;
  • later than five years;     
    • the total of future minimum sublease payments expected to be received under non­- cancelable subleases at the balance sheet date;
    • a general description of the lessee’s significant leasing arrangements including, but not limited to, the following:
      • The basis on which contingent rent payments are determined;
      • The existence and terms of renewal or purchase options and escalation clauses;
      • Restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.

Books of the Lessor

  • The lessor shall recognize the lease payments in the income statements and shall continue to treat the leased asset as a fixed asset.
    • The lessor shall adopt the normal depreciation policy for the leased asset but in addition he would make a separate disclosure regarding the depreciation on such assets and reconciliation statement for the lease payments receivable on periodic basis.
      • Disclosures by Lessor:

In addition to the requirements of AS 6, AS 10, and the governing statute, the lessor should make the following disclosures for operating leases (Para 46)

  1. For each class of assets:
  2. the gross carrying amount,
  3. the accumulated depreciation and accumulated impairment losses at the balance sheet date;
  4. the depreciation recognised, impairment losses recognized and impairment losses reversed in the statement of profit and loss for the period.
  5. Total contingent rents recognised as income in the statement of profit and loss for the period;
  6. Level I company should also disclose the following:
  7. The future minimum lease payments under non-cancelable operating leases in the    aggregate and for each of the following periods:
  8. not later than one year;
  9. later than one year and not later than five years;
  10. later than five years;
  • a general description of the lessor’s significant leasing arrangements; and
    • accounting policy adopted in respect of initial direct costs.

Accounting of Operating Leases

  • Lessor should treat assets given under operating leases as fixed assets in its balance sheets.
  • Depreciation should be recognized in the books of lessor.
  • The 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.
  • Initial direct costs are either charged to Profit and Loss Account of the year in which these are incurred or allocated to income over the lease term in proportion to the recognition of lease rent. 
  • Initial direct costs are either charged to Profit and Loss Account of the year in which these are incurred or allocated to income over the lease term in proportion to the recognition of lease rent. 

Accounting Entries of Operating Leases

In Books of Lessee : On payment of lease rent                          

 Lease Rent A/c Dr.
         To Bank A/c 
(Lease rent paid to lessor) 

At the end of financial year Lease Rent Account will be transferred to Profit and Loss Account. If lease rent has not been paid, entry for outstanding lease rent should be made at the end of accounting year.

Accounting Entries in Books of Lessor

  • On receipt of lease rent
        Bank A/cDr.
              To Lease Rent A/c 
        (lease rent received from lessee) 
  • For Depreciation at the end of year
        Depreciation A/cDr.
              To Assets (given on lease) A/c 

Note: Lease Rent and Depreciation Accounts will be transferred to Profit and Loss Account.

Sale and Lease Back Transactions

  1. Sale and leaseback agreements mean selling property for cash and then lease it back from the buyer. The property owner agrees to sell the property at an agreed valuation and lease it back from the buyer. The lessee or seller receives cash immediately and makes periodic payment in form of lease rents for right to use the property. The lease payments and the sale price are negotiated as a package.
    1. The accounting treatment of a sale and lease back depends upon the type of lease involved, are summarized below:-
  2. Sale and leaseback resulting in Finance Lease: The excess or deficiency of sales proceeds over the carrying amount should be deferred and amortised over the lease term in proportion to the depreciation of the leased asset.
  3. Sale and leaseback resulting in Operating Lease: 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.

After recognition of loss, if any, the profit / loss on sale of the asset should be treated in following manner:

  1. Case 1: Sale price = Fair Value

Profit or loss should be recognised immediately.

  1. Case 2: Sale Price is less than Fair Value

Profit should be recognised immediately. The loss should also be recognised 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.

  1. Case 3: Sale Price is more than Fair Value

The excess over fair value should be deferred and amortised over the ‘period for which the asset is expected to be used.

Finance Lease

Ex. The Suraj Manufacturing Company leased equipment from the JK Ltd. on July 1, 2002. The lease is approximately recorded as a purchase for JK Ltd. The lease is for an eight year period expiring on June 30, 2010. Equal annual payments under the lease are Rs.6,00,000 and due on July 1st of each year. The first payment was made on July 1, 2002. The cost of equipment on JK Ltd’s accounting records was Rs.30,00,000. The equipment has an estimated useful life of 8 years with no residual value expected. Suraj Manufacturing Company uses straight-line depreciation and takes full year depreciation in the year of purchase. The rate of interest contemplated by Suraj Manufacturing Company and JK Ltd. is 10%. The present value of an annuity of Re.1 in advance for eight years at 10% is 5.868.

You are required to find:

  1.  What expenses should Suraj Manufacturing Company appropriately record as a result of the above facts for the year ended 30th June, 2003.
  2. What income or loss before income taxes should JK Ltd. appropriately record as a result of the above facts for the year ended 30th June 2003,

Solution:

  1. a) Expenses of Suraj Manufacturing Company for the year ended 30th June, 2003:

 Annual cash Payment = Rs.6,00,000

 Present value of annuity of Re.1 in advance for 8 years @ 10% = 5.868.

 Present value of purchase price = (Rs.6,00,000 x 5.868) = Rs.35,20,800

 Depreciation = (Rs.35,20,800/8) = Rs.4,40,100

b) Computation of interest expenses:                                                 Rs.

Purchase price of the equipment                35,20,800
Less: Payment made of July 1, 2002         6,00,000
 29,20,800

         Interest for the year = (10% of Rs.29,20,800) = Rs.2,92,080

      c) Total expenses (a+b) = (Depreciation + Interest) = Rs.(4,40,100 + 2,92,080) = Rs.7, 32,180

The total expenses of Rs. Rs.7, 32,180 will be charged for the year ended 30th June, 2003

  1. Profit on sale:
 Rs.
        Present sale price Rs.(6, 00,000 x 5.868)             35,20,800
        Less: cost of equipment 30,00,000
                   Profit         5, 20,800

Interest Income:                                                

      Interest for the year = (Rs.29, 20,800 x 10%) = Rs.2,92,080

      Total Income = Rs.(5,20,800 + 2,92,080) =       Rs.8,12,880 will be recorded before income taxes in the book of JK Ltd.

Nature of Lease

Ex. Mr. D Chakraborty acquired a machine on lease, for 4 years on 1.1.2003. The fair value of the machine is Rs.1,20,000 and carrying value in the books of vendor is Rs.1,14,000. Mr. Chakraborty & lease vendor respectively incurred Rs.2, 000 and Rs.2,200 on negotiating lease. The amount payable is in 4 instalments viz, Rs.70,000 (1.1.2003), Rs.32,000 (31.12.2003), Rs.16,000 (31.12.2004), Rs.9,000 (31.12.2005). The lessee has also guaranteed as residual value at the end of economic life on 31.12.2006 of 5% of its cost to him. The machine is to be depreciated on Straight Line Method. Identify the nature of the lease and make relevant journal entries in the book of Mr. D Chakraborty when financing cost transacted was 14% p.a.

Solution:

Steps involved in solving the above problem:

  • Calculation of the status of lease (Finance or Operating).
  • Calculation of Finance Charges and Capital Recovery included in every instalment.
  • Passing Journal Entries in the books of Mr. D Chakraborty.

1. Nature of lease (Finance or Operating)

YearLease PaymentDiscount Factor 14% p.a.Present value of Lease Payment
0 1 2 3 470,000 32,000 16,000   9,000 (5% on Rs.1,20,000)   6,0001.000     .8772     .7695     .6750     .592170,000 28,070 12,312   6,075   3,553
                 1,20,010

Since, the present value of lease payment is approximately equal to fair value, it is a finance lease.

2. Calculation of Finance Charges and Capital Recovery included in every installment

Year (1)Outstanding Liabilities (Rs.) (2)Payment (Rs.) (3)Finance Charges (14% of outstanding liability in beginning of the year) (4)Capital Recovery (Rs.) (5=3-4)
1.1.03 31.12.03 31.12.04 31.12.05 31.12.06(1,20,000  – 70,000) = 50,000 (50,000+7,000– 32,000) = 25,000 (25,000+3,500-16,000) = 12,500 (12,500+1,750-9,000) = 5,250  70,000 32,000 16,000   9,000   6,000– 7,000 3,500 1,750    73570,000 25,000 12,500  7,250  5,265
12,985   1,20,015

 

   3.                                             Journal of Mr. D Chakraborty  Dr.  Cr.
DateParticulars Rs.Rs.
1-1-03Leased Machine A/c                                                                          To Lease Vendor (Machine purchased on lease recorded at fair value)Dr.1,20,000  1,20,000
Leased Machine A/c      To Bank A/c (Being Cost of negotiating lease recorded)Dr.2,000  2,000
Lease Vendor A/c     To Bank A/c (Payment of 1st Instalment)Dr.70,000  70,000
31-12-03Finance Charges A/c     To Lease Vendor (Finance charges due recorded)Dr.7,000  7,000
 Lease Vendor A/c     To Bank A/c (2nd Instalment  paid)Dr.32,000  32,000
Depreciation on Leased Machine A/c [(1,20,000 + 2,000) /4]     To Leased Machine A/c (Depreciation on leased machine)Dr.30,500  30,500
Profit & Loss A/c     To Depreciation on Leased Machine A/c     To Finance Charges A/c (Finance charges & depreciation transferred to Profit & Loss A/c)Dr.37,500  30,500 7,000
31-12-04Finance Charges A/c     To Lease Vendor A/c (Finance charges due recorded)Dr.3,500  3,500
Lease Vendor A/c       To Bank A/c (3rd Instalment paid)Dr.16,000  16,000
Depreciation on Leased Machine A/c     To Leased Machine A/c (Depreciation on leased machine)Dr.30,500  30,500
Profit & Loss A/c     To Depreciation on Leased Machine A/c     To Finance Charges A/c (Finance charges & depreciation transferred to Profit & Loss A/c)Dr.34,000  30,500           3,500
31-12-05Finance Charges A/c     To Lease Vendor A/c (Finance charges due recorded)Dr.1,750  1,750
Lease Vendor A/c     To Bank A/c (4th Instalment paid)Dr.9,000  9,000
Depreciation on Leased Machine A/c     To Leased Machine A/c (Depreciation on leased machine)Dr.30,500  30,500
Profit & Loss A/c     To Depreciation on Leased Machine A/c     To Finance Charges A/c (Finance charges & depreciation transferred to Profit & Loss A/c)Dr.32,250  30,500 1,750
31-12-06Finance Charges A/c      To Lease Vendor A/c (Finance charges due recorded)Dr.735  735
Lease Vendor A/c      To Bank A/c (Guaranteed residual value paid)Dr.6,000  6,000
Depreciation on Leased Machine A/c    To Leased Machine A/c (Depreciation on leased machine)Dr.30,500  30,500
Profit & Loss A/c      To Depreciation on Leased Machine A/c     To Finance Charges A/c (Finance charges & depreciation transferred to Profit & Loss A/c)Dr.31,235  30,500 735

Note: Since, there is no certainty that lessee will obtain the ownership of the asset, the asset is fully depreciated over the lease

           term or its useful life, whichever is lower, as per provisions contained in Para 18 of AS-19.

Net Investment in Lease

Ex. Mr. Bakshi has taken the assets on lease from Q Ltd. The following information is given below:

Lease term                                        4 years

Fair value at inception of lease        Rs.21,00,000

Lease Rent                                       Rs.6,00,000 p.a. at the end of year

Guaranteed Residual Value             Rs.2,00,000

Expected Residual Value                 Rs.4,00,000

Implicit Interest Rate                         Rs.14.97%

How the accounting is done in the books of lessor?

Solution: Lessor should recognize asset given under lease at net investment in lease.

Net investment in lease = Gross investment – unearned finance income

Gross Investment          = Minimum Lease Payment or MLP* + Guaranteed Residual Value + 

                                          Unguaranteed Residual Value

                                       = Rs.[24,00,000 + 2,00,000 +(4,00,000 – 2,00,000)]

                                       = Rs.28,00,000

* MLP = (6,00,000 x 4years) = Rs.24,00,000

Unearned Finance Income = Gross investment – Present value of gross investment (as shown below)

 = Rs.(28,00,000 – 19,42,900) = Rs.8,57,100

YearPresent Value of MLPGross Investment discount factorPresent Value (Rs.)
1 2 3 46,00,000 6,00,000 6,00,000 10,00,0000.8698 0.7565 0.6580 0.57245,21,880 4,53,900 3,94,800 5,72,400
28,00,00019,42,980
   (say Rs.19,42,900)

Apportionment of MLP into Capital Recovery & Finance Income

Year       (1)Outstanding Balance of lease     (2)Cash Receipt     (3)Finance Charges (14.97% of outstanding Balance at beginning of the year) (4)Capital Recovery reduced from receivable   (5 = 3 – 4)
0 1 2 3 421,00,000 (21,00,000- 2,85, 630)= 18,14,370 (18,14,370 – 3,28,388)= 14,85,982 (14,85,982 – 3,77,549)=  11,08,433 –– 6,00,000 6,00,000 6,00,000 10,00,000  – 3,14,370 2,71,612 2,22,451 1,65,932– 2,85,630 3,28,388 3,77,549 8,34,068
9,74,36518,25,635

The lease receivable account shown in the books of lessor will not tally with the lease liability account as shown by the lessee in his book. Difference will remain because of guaranteed residual value from the third party or/and unguaranteed residual value from the lessee point of view.

Computation of Interest on Hire Purchase in Financial Lease

Ex. ABC Associates entered into a financial lease agreement on 1.4.1995 with Flexible Leasing Ltd. for lease of a car. The price of the car was Rs.2,00,000 and the quarterly lease rentals were agreed at Rs.90 per thousand payable at the beginning of every quarter. ABC Associates kept up their payments but by 25.3.1996 they approached and obtained the consent of the leasing company for treating the arrangement as one of Hire-purchase from the beginning, on the following terms:

Period                : 3 years

Quarterly hire    : Rs.30,000 payable at the beginning of the quarter.

It was agreed that the lease rentals paid will be treated as hire monies and that the balance due upto 31.3.1996 will be settled by ABC Associates on that date with interest at 18% p.a. on various instalments due during the year. The rate of depreciation on the car is 25%.

Show the following accounts in the books of ABC Associates for the year 1995-96:

Flexible Leasing Ltd.’s A/c, Interest Suspense A/c.

Calculations are to be rounded off to the nearest rupee.

Solution:

Steps involved in solving the above problem-

  • Calculation of Amount of Quarterly Lease Rental paid.
  • Calculation of Difference Payable on 31.3.1996 and Interest.
  • Ascertainment of Total Amount of Interest on Hire Purchase.
  • Calculation of Interest on Hire Purchase Attributable to the year 1995-1996.
  • Preparing Flexible Leasing Limited A/c (in the Books of ABC Associates).
  • Preparing Interest Suspense A/c (in the Books of ABC Associates).

Working Details: 

1. Amount of quarterly lease rental paid = Rs.(2,00,000 x 90/1,000) = Rs.18,000

2.            Calculation of Difference Payable on 31.3.1996 and Interest

DateQuarterly Hire Charges (Rs.)Quarterly Lease Rental Paid (Rs.)Difference Payable (Rs.)Interest (18% p.a.)Amount of Interest (Rs.)
  From  To
1.4.95 1.7.95 1.10.95 1.1.9630,000 30,000 30,000 30,00018,000 18,000 18,000 18,00012,000 12,000 12,000 12,0001.4.95 1.7.95 1.10.95 1.1.9631.3.96 31.3.96 31.3.96 31.3.962,160 1,620 1,080 540
72,00048,0005,400
Amount Payable on 31st March, 1996: 
 Rs.
Balance due48,000
Interest due5,400
 53,400  

3. Ascertainment of Total Amount of Interest on Hire Purchase

 Rs.
    Hire Purchase Price of the car (Rs.30,000 x 12 instalments)3,60,000
    Less: Cash Price2,00,000
    Total amount of Interest1,60,000

4. Calculation of Interest on Hire Purchase Attributable to the year 1995-1996

    The amount of Interest of Rs.1,60,000 will be apportioned in the 3 year period as below:

ParticularsNo. of due instalmentsCalculation of InterestInterest (Rs.)
1995-96 Due Date. 1.4.95                  1.7.95                  1.10.95                  1.1.96  – 11 10 9  – Rs.1,60,000 x 11/66 Rs.1,60,000 x 10/66    Rs.1,60,000 x 9/66 Total (A)  – 26,667 24,242 21,818
72,727
1996-97 Due Date. 1.4.96                  1.7.96                  1.10.96                  1.1.97  8 7 6 5  Rs.1,60,000 x 8/66 Rs.1,60,000 x 7/66 Rs.1,60,000 x 6/66 Rs.1,60,000 x 5/66 Total (B)  19,394 16,970 14,545 12,121
63,030
1997-98 Due Date. 1.4.97                  1.7.97                  1.10.97                  1.1.98  4 3 2 1  Rs.1,60,000 x 4/66 Rs.1,60,000 x 3/66 Rs.1,60,000 x 2/66 Rs.1,60,000 x 1/66 Total (C) Total (A+B+C)  9,697 7,273 4,848 2,425
       24,243
66    1,60,000

On the basis of above computation, Flexible Leasing Ltd.s’ A/c and Interest Suspense A/c in the books of ABC Associates is shown below:

5.                                                                         Books of ABC Associates

Flexible Leasing Limited Account

Dr.    Cr.
DateParticularsRs.DateParticularsRs.
1996 March 25 March 31 March 31  To Lease Rental A/c (Note-2) To Bank (Note-2) To Balance c/d    72,000 53,400 2,40,0001996 March 25 March 25 March 31  By Car on Hire Purchase A/c By Interest Suspense A/c (Note-3) By Interest A/c (Note-2)  2,00,000 1,60,000 5,400
3,65,4003,65,400

6.                                                                            Interest Suspense Account

Dr.    Cr.
DateParticularsRs.DateParticularsRs.
1996 March 25    To Flexible Leasing Ltd. A/c      (Note-3)    1,60,0001996 March 31   March 31  By Interest on Hire Purchase A/c       (Note-4) By Balance c/d    72,727 87,273
1,60,0001,60,000

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