Accounting /Reporting

Framework and Taxation of

Leasing

Ch.- 3 , Financial Services

M Y Khan
Accounting for leases by a lessee
 Main concerns:
 Appropriate accounting necessary,for income
recognition for the lessor and asset disclosure for the
lessee.
 Likely distortion in the profit and loss account if lease
rental is recognized as per the lease agreement.
 Distortions are also likely to occur if the assets taken
on lease are not disclosed in the lessees’ balance
sheet.
 Accounting Standards :
 IAS - 17 & AS 19
IAS -17 Framework
 Accounting for Leases by a Lessee:
 Finance Lease:
 A finance lease should be shown in Lessee’s balance
sheet as an asset and a liability an amount which is
Lower of :
 - Fair value of the lease asset net of grants and tax
credits or
 - Present Value of the minimum lease payments.
 The discount factor to be used is ROI of the lease .
Finance Lease in the Lessee’s
books….
 The rentals should be appropriated as finance charg+
 e & reduction from the O/S liability. .
 The finance charge should be allocated to the periods
during the lease term, so as to produce a constant
periodic rate of interest. Some form of approximation
to be used for this.
 Finance Lease gives rise to Depreciation Charge +
Finance charge for each accounting period. Dep
charge to be consistent with Dep Policy for other
owned assets and IAS-4
Operating lease In Lessee’s
books
 In case of operating lease, in the
lessee’s books the rental expenses for
the accounting periods should be
charged to income.
 The rentals should be recongised in a
systematic manner, taking into account
the time pattern of the user’s benefit.
Disclosure in Financial
Statements of Lessees
 Disclosure of each asset that are subject to
Finance lease at each balance sheet date.
 Liabilities related to these leased assets
should be separately shown from other
liabilities, differentiating between current and
long term portions.
 Disclosure of significant financing restrictions,
renewal options, contingent rentals, other
contingencies arising from leases.
Accounting for Leases by
Lessors
 Finance Leases :
 An asset held under a finance lease should be
recorded not as Property, Plant&Equip. but as a
Receivable, at an amt. Equal to net investment in the
lease.
 Recognition of finance income, should be at a
constant periodic rate of return on lessor’s net
investment outstanding or cash investment
outstanding in respect of the finance lease.
 Inclusion of selling profit or loss in income , as per
policy for outright sales.
Accounting for Leases by
Lessors…...
 Assets held for Operating Leases, should be
recorded as property, plant & Equipment in the
balance sheet of the lessor.
 Rental income to be recognized on straight line basis
over the lease term,unless other systematic basis
representing the time pattern of the earning process
is devised.
 Depreciation of leased asset , should be consistent
with the Lessor’s normal depreciation policy, for other
assets.
Accounting for Leases by
Lessors…...
 Sale and Leaseback Transactions ;
 If sale and leaseback results in a Financial Lease,
then the excess of sales proceeds over the carrying
amount, should not be immediately recognized in the
books of the lessee. It should be deferred and
amortized over the lease term.
 If the above results in an Operating Lease then any
profit or loss is to be recognized immediately.
 If there is a loss, then should be recognized
immediately, except if loss is compensated by
reduction in some of the future rentals .
 In such case the loss is deferred over the period for
which the asset is to be used.
Disclosure in the Financial
Statement of the Lessors
 Disclosures should be made on each balance sheet
date of the gross investments in Leases.
 To be reported by the lessor as Finance Leases, and
the related unearned finance income and
unguaranteed residual value of the leased assets,
also to be reported.
 The finance income to be reported at systematic
constant periodic rate.
 Where significant part of the lessor’s business
comprises operating leases, the lessor should
disclose the amount of the asset by each class of
asset, with related accumulated depreciation, in B/S.
IAS 17 - for finance lease in
books of the lessor
 Finance lease gives two types of incomes - Profit/loss
from the outright sale, Finance income inherent in the
transaction.
 Therefore the sales revenue should be accounted by
taking lower of the below values :
 - Determination of the present value of the minimum
Lease rentals + unguaranteed residual value at the
Commercial rate of interest.
 - Fair market value of the leased equipment.