Leasing is an important source of medium- and long-term financing for entities. Accounting Standard 19 — Leases prescribes the accounting treatment and disclosures. The classification of a lease can have a significant impact on the financial statements of both the lessor and lessee.

A ‘finance lease’ transfers substantially all the risks and rewards incident to ownership, while an ‘operating lease’ does not. Risks include likelihood of losses from idle capacity or technological obsolescence and variations in return due to changing economic conditions. Rewards could be the expected profitable operation over the economic life of the asset, gain from appreciation in value or realisation of residual value. The classification depends on the substance of the transaction rather than its form.

Finance Lease

For the lessor, asset given under a finance lease is recognised in its balance sheet as a receivable; lease payments received are apportioned between the finance income and the reduction of the outstanding receivable.

For the lessee, at inception, an asset and a liability are recognised; lease payments made are apportioned between the finance charge and the reduction of the outstanding liability; the leased asset is depreciated.

Operating Lease

For the lessor, asset given under operating lease is recognised in its balance sheet under fixed assets; lease payments received are recognised as an income in the statement of profit and loss; the leased asset is depreciated.

For the lessee, lease payments made are recognised as an expense in the statement of profit and loss, generally on a straight-line basis over the lease term.

AS-19 also provides guidance on more complex areas such as sale and leaseback, manufacturer or dealer lessor. The accounting treatment of a sale and leaseback transaction depends on the type of lease involved.

Additional complexities arise when involving lessor as manufacturer or dealer, wherein low rates of interest are quoted to attract customers. With such a rate, an excessive portion of the total income from the transaction would be recognised at the time of sale. When low rates of interest are quoted, under AS-19 the selling profit would be limited to what would accrue under a commercial rate of interest.

The lessee applies AS-28 to determine whether an asset recognised under finance lease is impaired. The lessee evaluates the operating lease contracts under AS-29 to determine whether it is an onerous contract.

Ind AS-17 is the main accounting standard for leases and was introduced as part of the convergence with IFRS (International Financial Reporting Standards).

Like under AS-19, the key principles for classification of leases under Ind AS-17 are based on substance over form and transfer of risks and rewards. The accounting treatment of finance and operating leases are also generally similar.

Under IFRS, the IFRIC-4 — ‘Determining whether an Arrangement contains a Lease’ expands the scope of leases by including certain arrangements in the scope of Ind AS-17. The requirements of IFRIC-4 are also included in Ind AS-17, though they may apply at a later date.

AS-19 excludes lease agreements for land use, while Ind AS-17 does not exclude them, except for certain investment property.

Under Ind AS-17, more arrangements will be recorded as lease as compared with AS-19.

Companies should carefully assess lease arrangements on factors such as classification, lease incentives, off-market lease terms and so on, to determine the appropriate accounting treatment. The accounting implications under Ind AS should be factored in to better evaluate options and take appropriate action.

Harinderjit Singh is Partner, Price Waterhouse

Ashish Taksali,Senior Manager, contributed to the article.

Related Topics