20 November 2009
Co. A constructed floating dock for Rs. X. Funding was done through bank financing and hence the dock was pledged in favour of the bank.
Immediately after construction of the dock, Co. A gives dock on 20 years lease to co. B for Rs.X (being the full amount of its construction cost).
As per the terms of the lease agreement, Co. B has right to extend the lease for such further period as mutually agreed, but not less than 3 years.
- How should Co. B account for the above lease transaction?
- Will the treatment differ if Co. A has shown the dock as its fixed Asset in its balance sheet?
- Will the treatment differ if Co. A owns 30% shareholding in Co. B?
20 November 2009
A lease agreement does not transfer the ownership of an asset it only allows the use of the asset for a consideration for a certian period.The asset belongs to Co A As far as Co B is concerned lease rent is an expense to be accounted as such. If u are familiar with holding/subsidiary company accounts only minority interest is disclosed seperately in the holding company's Balance Sheet. As per Cos Act 1956 consolidated Balance Sheet is passe and interest in subsidiary is disclosed by way of a statement u/s 212
20 November 2009
I think you did not get my question.
As per IAS 17, a lease is treated as finance lease if one of the four criteria given therein.
One of the criteria is taht the present value of the minimum lease payments is equal to the substantially all of the fair value of the leased asset.
another criteria is that the lease term is for the major part of the economic life of the leased asset.
In the given case, Co. A has give the dock on lease for Rs. X which represent its full construction cost and hence the full cost of the asset is recovered from this lease. Further the lease agreement is for 20 years and Co. B has right to extend it for further period, but not less than 3 years.
Considering the above, the lease agreement looks like a finance lease and hence Co.B can capitalise the floating dock.
Now one of the questions raised is - In the given case do you feel that this is a finance lease?
- Will the accounting treatment differ if Co. A has taked floating dock as its fixed asset in its balance sheet.
- Further, in case Co.A has less than 50% shareholding in Co.B, will this fact affect the accounting treatment?
30 November 2009
Hi Madhusudan, nice question. I assume the co. in ur eg. is not an Indian co. to give you the reply, i need clarification on few points : 1) As u said that co. B takes the floating docks on lease for an amount equal to cost of construction, Is cost of construction equal to Fair value as at the inception of lease? 2)Whether lease rental (total amount) will be paid at the inception of lease? 3) What is lessors IRR? 4) what is the expected useful life of the floating docks? as far as i understand it is used to repair the ships. I will reply your query soon after u give the answers of abovementioned Questions. Regards, CA Shakuntala Chhangani
04 December 2009
point wise answer is given below: 1. Yes. 2. Cost of floating dock will be paid out in first year.After this certian amount will be paid on yearly basis. 3. not calculated. 4. 30 years.
11 December 2009
Hi Madhu, your pointwise answer is: 1)It is a finance lease in terms of IAS 17 as it covers major part of the life of the asset. the leasee will show asset as well as a liability at lower of fair value or PV of MLP at the inception of lease applying lessor's IRR or leasee's incremental borrowing cost, as the case may be, as discounting factor. 2)if the leasee shows it as an asset, lessor should show it as receivables. In any case, presentation in the books of lessor will not affet the accounting treatment of leasee. 3) The transaction should be at arm's length. the lessor as well as leasee are required to make proper disclosures under IAS 24 (AS 18) regarding the same if co. A has less than 50% shareholding . Regards, CA Shakuntala Chhangani
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