A company (Level-3 entity)has entered into a lease agreement for 10 years for Office premises for a sum of Rs. 100,000/- p.a. subject to increase of rental @10%p.a. from 3rd year.
What are the disclosure requirements in Notes to Accounts would be applicable as well as what is the treatment to be done in books of accounts wrt SLM calculations ??
14 July 2024
### Treatment of Building Lease under AS 19
When a company leases office premises under a lease agreement with increasing rent, here’s how you should approach the disclosure requirements in the Notes to Accounts and the treatment in the books of accounts, specifically considering the Straight-Line Method (SLM) for lease expense recognition.
### Disclosure Requirements in Notes to Accounts:
1. **Nature of Lease:** - Describe the nature of the lease, including the duration (10 years), any renewal or termination options, and the terms and conditions of the lease agreement.
2. **Future Minimum Lease Payments:** - Disclose the future minimum lease payments under non-cancellable leases as of the balance sheet date, broken down into periods of up to one year, between one and five years, and more than five years.
3. **Rental Escalation Clause:** - Clearly state the rental escalation clause, which increases by 10% annually from the 3rd year onwards. Explain how this will impact future lease payments and lease expense recognition.
4. **Sublease Income:** - If applicable, disclose any sublease income expected to be received under non-cancellable subleases as of the balance sheet date.
5. **Other Lease Terms:** - Provide details of any other significant leasing terms and conditions that could affect the company's financial position and performance.
### Treatment in Books of Accounts - Straight-Line Method (SLM):
1. **Initial Recognition:** - Recognize a leased asset and a lease liability initially at the present value of the minimum lease payments at the inception of the lease.
2. **Subsequent Measurement - Lease Liability:** - Measure the lease liability at amortized cost using the effective interest method, applying the interest rate implicit in the lease if practicable; otherwise, use the incremental borrowing rate.
3. **Subsequent Measurement - Leased Asset:** - Recognize the leased asset at an amount equal to the initial measurement of the lease liability, adjusted for lease payments made and accretion of interest on the lease liability.
4. **Lease Expense Recognition:** - Recognize lease payments in the Statement of Profit and Loss on a straight-line basis over the lease term, unless another systematic and rational basis is more representative of the time pattern in which use benefit derived from the leased asset is diminished.
5. **Annual Adjustments for Rental Increases:** - Adjust the lease expense annually to reflect the increase in rental payments according to the terms of the lease agreement. For example: - Year 1: Rs. 100,000 - Year 2: Rs. 100,000 - Year 3: Rs. 110,000 (10% increase applied) - Year 4: Rs. 121,000 (10% increase applied to Year 3 rent) - And so on, until the end of the lease term.
### Example Calculation for SLM:
- Assuming a lease term of 10 years with annual payments of Rs. 100,000: - Total lease payments over 10 years: Rs. 1,000,000 - Annual lease expense: Rs. 100,000
- Adjust for rental increase from Year 3 onwards: - Year 3: Rs. 110,000 - Year 4: Rs. 121,000 - And so forth, applying the 10% increase each year.
### Conclusion:
By following these guidelines for disclosure and treatment under AS 19, the company ensures compliance with accounting standards and provides stakeholders with transparent information about its lease commitments and financial implications. Proper application of the Straight-Line Method for lease expense recognition ensures that lease-related costs are accurately reflected in the financial statements over the lease term.
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