Basic - Operating and Finance Lease

LEASE (FINANCE AND OPERATING)

AS -17

Definition:-

Finance Lease:- A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. In other words Finance lease can be a lease under which the present value of the minimum  lease payments at the inception of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset.

Examples of Finance Lease:-

a. The lease transfers ownership of the asset to the lessee by the end of the lease term;

b. The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised;

c. The lease term is for the major part of the economic life of the asset even if title is not transferred;

d. At the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset;

e. the leased assets are of such a specialised nature that only the lessee can use them without major modifications

RECOGNITION

A. Initial Recognition:-

At the commencement of the lease term, lessees shall recognize finance leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease. The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee’s incremental borrowing rate shall be used. Any initial direct costs of the lessee are  added to the amount recognized as an asset.

B. Subsequent Recognitions:-

For Lease Payment:- Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rents shall be charged as expenses in the periods in which they are incurred.

For Depreciation:- A finance lease gives rise to depreciation expense for depreciable assets as well as finance expense for each accounting period. The depreciation policy for depreciable leased assets shall be consistent with that for depreciable assets that are owned, and the depreciation recognized shall be calculated. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset shall be fully depreciated over the shorter of the lease term and its useful life.

General Guidelines:-

The sum of the depreciation expense for the asset and the finance expense for the period is rarely the same as the lease payments payable for the period, and it is, therefore, inappropriate simply to recognise the lease payments payable as an expense. Accordingly, the asset and the related liability are unlikely to be equal in amount after the commencement of the lease term.

Disclosure

i. For each class of assets, the net carrying amount at the end of the reporting period.

ii. (disclosure by way of notes to accounts) A reconciliation between the total of future minimum lease payments at the end of the reporting period, and their present value. In addition, an entity shall disclose the total of future minimum lease payments at the end of the reporting period, and their present value, for each of the following periods:

a. not later than one year;

b. later than one year and not later than five years;

c. later than five years.

OPERATING LEASE:-

If  the lease  does not transfer substantially all the risks and rewards incidental to ownership called Operating Lease.  Or in other words “Other than finance lease”.

Examples of Operating Lease:-

A company is about to enter into a three-year lease to rent a building. The lease cannot be cancelled and there is no certainty of renewal. The landlord retains responsibility for maintaining the premises in good repair, technically this lease is classified as an operating lease.

Recognition:-

Lease rentals should be accounted for on accrual basis over the lease term so as to recognize an appropriate charge in this respect in the profit and loss account with a separate disclosure thereof. In other words, aggregate of the lease rentals payable over the lease term should, unless another systematic basis is more representative of the time pattern, be spread over the term on straight line basis, irrespective of the payment schedule as per the terms and conditions of the lease. The excess of lease rentals paid over the amount accrued in respect thereof should be treated as prepaid lease rental and vice versa.

A BRIEF COMPATIVE CHART BETWEEN FINANCE AND OPERATING LEASE

TAX CONCERN:-

FINANACE LEASE:-

I. Tax depreciation  is allowable under Income Tax.

II. Finance charges towards payment of lease payment is allowable expenditure under income tax act.

OPERATING LEASE:-

Any payment towards operating lease is allowable expenditure.