19. AS 19
19. AS 19
AS 19 - LEASES
Illustration 1 (MTP Nov’21, Oct’22, April’23) (Past Exam May’19)
S. Square Private Limited has taken machinery on finance lease from S.K. Ltd. The information is as under:
Lease term = 4 years
Fair value at inception of lease = ₹ 20,00,000
Lease rent = ₹ 6,25,000 p.a. at the end of year
Guaranteed residual value = ₹ 1,25,000
Expected residual value = ₹ 3,75,000
Implicit interest rate = 15%
Discounted rates for 1st year, 2nd year, 3rd year and 4th year are 0.8696, 0.7561, 0.6575 and 0.5718
respectively.
Calculate the value of the lease liability as per AS-19 and disclose impact of this on Balance sheet and
Profit & loss account at the end of year 1 (5 Marks)
Solution
According to para 11 of AS 19 “Leases”, the lessee should recognise the lease as an asset and a liability at
an amount equal to the lower of the fair value of the leased asset at the inception of the finance lease and
the present value of the minimum lease payments from the standpoint of the lessee.
In calculating the present value of the minimum lease payments the discount rate is the interest rate implicit
in the lease. Present value of minimum lease payments will be calculated as follows:
Year Minimum Lease Implicit interest rate Present value ₹
Payment ₹ (Discount rate @15%)
1 6,25,000 0.8696 5,43,500
2 6,25,000 0.7561 4,72,563
3 6,25,000 0.6575 4,10,937
4 7,50,000* 0.5718 4,28,850
Total 26,25,000 18,55,850
Present value of minimum lease payments ₹ 18,55,850 is less than fair value at the inception of lease i.e. ₹
20,00,000, therefore, the asset and corresponding lease liability should be recognised at ₹ 18,55,850 as
per AS 19.
Illustration 2
Prakash Limited leased a machine to Badal Limited on the following terms:
(₹ In lakhs)
(i) ₹Fair value of the machine 28.3
(ii) ₹Lease term 5 years
(iii) ₹Lease rental per annum 8.00
(iv) ₹Guaranteed residual value 1.60
(v) ₹Expected residual value 3.00
(vi) ₹Internal rate of return 15%
Discounted rates for 1st year to 5th year are 0.8696, 0.7561, 0.6575, 0.5718, and 0.4972 respectively.
Ascertain Unearned Finance Income.
Solution
Illustration 3
A Ltd. sold machinery having WDV of ₹ 40 lakhs to B Ltd. for ₹ 50 lakhs and the same machinery was
leased back by B Ltd. to A Ltd. The lease back is operating lease.
Comment if –
a) Sale price of ₹ 50 lakhs is equal to fair value.
b) Fair value is ₹ 60 lakhs.
c) Fair value is ₹ 45 lakhs and sale price is ₹ 38 lakhs.
d) Fair value is ₹ 40 lakhs and sale price is ₹ 50 lakhs.
e) Fair value is ₹ 46 lakhs and sale price is ₹ 50 lakhs
f) Fair value is ₹ 35 lakhs and sale price is ₹ 39 lakhs.
Solution
Following will be the treatment in the given cases:
(a) When sales price of ₹ 50 lakhs is equal to fair value, A Ltd. Should immediately recognise the profit of ₹
10 lakhs (i.e. 50 – 40) in its books.
(b) When fair value is ₹ 60 lakhs then also profit of ₹ 10 lakhs should be immediately recognised by A Ltd.
(c) When fair value of leased machinery is ₹ 45 lakhs & sales price is ₹ 38 lakhs, then loss of ₹ 2 lakhs (40
– 38) to be immediately recognised by A Ltd. in its books provided loss is not compensated by future lease
payment, otherwise defer and amortise the loss.
Illustration 4
Explain the types of lease as per AS 19.
Solution:
For the purpose of accounting AS 19, classifies leases into two categories as follows:
1. Finance Lease
2. Operating Lease
Finance Lease:
It is a lease, which transfers substantially all the risks and rewards incidental to ownership of an asset to
the lessee by the lessor but not the legal ownership.
As per para 8 of the standard, in following situations, the lease transactions are called Finance lease:
1. The lessee will get the ownership of leased asset at the end of the lease term.
2. The lessee has an option to buy the leased asset at the end of the lease term at price, which is lower
than its expected fair value at the date on which option will be exercised.
3. The lease term covers the major part of the life of asset even if title is not transferred.
4. At the beginning of lease term, present value of minimum lease rental covers the initial fair value.
5. The asset given on lease to lessee is of specialized nature and can only be used by the lessee without
major modification.
Operating Lease:
It is lease, which does not transfer all the risks and rewards incidental to ownership.
Illustration 5
Explain the accounting treatment for a sale and leaseback transaction under Operating lease.
Solution:
As per AS 19, where sale and leaseback results in operating lease, then the accounting treatment in
different situations is as follows:
Situation 1: Sale price = Fair Value
Profit or loss should be recognized immediately.
Situation 2: Sale Price < Fair Value
Profit should be recognized immediately. The loss should also be recognized immediately except that, if the
loss is compensated by future lease payments at below market price, it should be deferred and amortized
in proportion to the lease payments over the period for which the asset is expected to be used.
Situation 3: Sale Price > Fair Value
The excess over fair value should be deferred and amortized over the period for which the asset is
expected to be used.
Illustration 6
What do you understand by the term “Interest rate implicit on lease”?
Solution:
= 130% of ₹ 1,50,000 ×
Illustration 11
B&P Ltd. availed a lease from N&L Ltd. The conditions of the lease terms are as under:
(i) Lease period is 3 years, in the beginning of the year 2009, for equipment costing ₹ 10,00,000 and has an
expected useful life of 5 years.
(ii) The Fair market value is also ₹ 10,00,000
(iii) The property reverts back to the lessor on termination of the lease.
(iv) The unguaranteed residual value is estimated at ₹ 1,00,000 at the end of the year 2011.
(v) 3 equal annual payments are made at the end of each year.
(vi) Consider IRR = 10%.
The present value off ₹ 1 due at the end of 3rd year at 10% rate of interest is ₹ 0.7513. The present value
of annuity of ₹ 1 due at the end of 3rd year at 10% IRR is ₹ 2.4868.
State whether the lease constitute finance lease and also calculate unearned finance income.
Solution:
Computation of annual lease payment:
Particulars ₹
Cost of equipment 10,00,000
Unguaranteed residual value 1,00,000
Present value of unguaranteed residual value (₹ 1,00,000 x 0.7513) 75,130
Present value of lease payments (₹ 10,00,000 - ₹ 75,130) 9,24,870
Present value of annuity for three years is 2.4868
Annual lease payment [9,24,870/2.4868] 3,71,911.70
Classification of lease:
Parameter 1:
The present value of lease payment i.e., ₹ 9,24,870 which equals 92.48% of the fair market value i.e., ₹
10,00,000.
The present value of minimum lease payments substantially covers the fair value of the leased asset
Parameter 2:
Illustration 12 (MTP Oct’20, Oct’21) (Past Exam May’18, Jan’21) (RTP Nov 20, May’22)
X Ltd. sold machinery having WDV of ₹ 300 lakhs to Y Ltd. for ₹ 400 lakhs and the same machinery was
leased back by Y Ltd. to X Ltd. The lease back arrangement is operating lease.
Give your comments in the following situations:
(i) Sale price of ₹ 400 lakhs is equal to fair value.
(ii) Fair value is ₹ 450 lakhs.
(iii) Fair value is ₹ 350 lakhs and the sale price is ₹ 250 lakhs.
(iv) Fair value is ₹ 300 lakhs and sale price is ₹ 400 lakhs.
(v) Fair value is ₹ 250 lakhs and sale price is ₹ 290 lakhs. (5 Marks)
Solution:
Accounting Treatment:
S. No. Particulars Accounting Treatment
(i) When sale price of ₹ 400 lakhs is equal to fair X Ltd. should immediately recognize the
value profit of ₹ 100 lakhs (i.e. 400 – 300) in its
books.
(ii) When fair value is ₹ 450 lakhs Profit of ₹ 100 lakhs should be immediately
recognized by X Ltd.
(iii) When fair value of leased machinery is ₹ 350 Then loss of ₹ 50 lakhs (300 – 250) to be
lakhs & sales price is ₹ 250 lakhs immediately recognized by X Ltd. in its
books provided loss is not compensated by
future lease payment.
(iv) When fair value is ₹ 300 lakhs & sales price is Then, profit of ₹ 100 lakhs is to be deferred
₹ 400 lakhs and amortized over the lease period.
(v) When fair value is ₹ 250 lakhs & sales price is Then the loss of ₹ 50 lakhs (300-250) to be
₹ 290 lakhs immediately recognized by X Ltd. in its
books and profit of ₹ 40 lakhs (290-250)
should be amortized/ deferred over lease
period.
Rs. Rs.
Asset A/c Dr. 1,91,500
To Lessor (Lease Liability) A/c 1,91,500
(Being recognition of finance lease as asset and liability)
₹
Total lease payments (₹ 6,43,500 x 3) 19,30,500
Add: Unguaranteed residual value 1,33,500
Gross investment in the lease 20,64,000.00
Less: Present value of investment (lease payments and residual value) (₹ 1,00,258.5+ (16,99,999.50)
₹ 15,99,741)
Unearned finance income 3,64,000.50
3. In case of finance lease, if the asset is returned back to the lessor at the end of the lease term - the
lessee always claims depreciation based on which of the following:
(a) Useful life.
(b) Lease term.
(c) Useful life or lease term whichever is less.
(d) Useful life or lease term whichever is higher.
4. AS 19 lays down 5 deterministic conditions to classify the lease as a finance lease. To classify the lease
as an operating lease – which statement is correct?
(a) Any 1 condition fails.
(b) Majority of the 5 conditions fail.
(c) All 5 conditions fail.
(d) Any 2 conditions fails.
SOLVED EXAMPLE
Example 1
Annual lease rents = ₹ 50,000 at the end of each year.
Lease period = 5 years;
Guaranteed residual value = ₹ 25,000
Unguaranteed residual value (UGR) = ₹ 15,000
Fair Value at the inception (beginning) of lease = ₹ 2,00,000
Interest rate implicit on lease is computed below:
Interest rate implicit on lease is a discounting rate at which present value of minimum lease payments and
unguaranteed residual value is ₹ 2 lakhs.
PV of minimum lease payments and unguaranteed residual value at guessed rate 10%
Year MLP + UGR DF (10%) PV
₹ ₹
l 50,000 0.909 45,450
2 50,000 0.826 41,300
3 50,000 0.751 37,550
4 50,000 0.683 34,150
5 50,000 0.621 31,050
5 25,000 0.621 15,525
5 15,000 0.621 9,315
2,14,340
PV of minimum lease payments and unguaranteed residual value at guessed rate 14%
Year MLP + UGR DF (14%) PV
₹ ₹
1 50,000 0.877 43,850
2 50,000 0.769 38,450
3 50,000 0.675 33,750
4 50,000 0.592 29,600
5 50,000 0.519 25,950
5 25,000 0.519 12,975
5 15,000 0.519 7,785
1,92,360
Example 2
Annual lease rents = ₹ 50,000 at the end of each year.
Lease period = 5 years;
₹ ₹
Asset A/c Dr. 1,91,500
To Lessor (Lease Liability) A/c 1,91,500
(Being recognition of finance lease as asset and liability)
Example 3
Using data for example 2 and assuming zero residual value, allocation of finance charge over lease period
is shown below:
Year Minimum Lease Finance Charge Principal ₹ Principal due ₹
Payments ₹ (12.6%)₹
0 -- -- -- 1,91,500
1 50,000 24,129 25,871 1,65,629
2 50,000 20,869 29,131 1,36,498
3 50,000 17,199 32,801 1,03,697
4 50,000 13,066 36,934 66,763
5 75,000 8,237* 66,763
2,75,000 83,500 1,91,500
Accounting entries in year 1 to recognise the finance charge in books of lessee are suggested below:
₹ ₹
Finance Charge A/c Dr. 24,129
To Lessor 24,129
(Being finance charge due for the year)
Lessor Dr. 50,000
To Bank A/c 50,000
(Being payment of lease rent for the year)
P & L A/c Dr. 24,129
To Finance Charge A/c 24,129
(Being recognition of finance charge as expense for the year)
Example 4
In example 2, suppose unguaranteed residual value is not determinable and lessee’s incremental
borrowing rate is 10%.
Since interest rate implicit on lease is discounting rate at which present value of minimum lease payment
and present value of unguaranteed residual value equals the fair value, interest rate implicit on lease
cannot be determined unless unguaranteed residual value is known. If interest rate implicit on lease is not
determinable, the present value of minimum lease payments should be determined using lessee’s
incremental borrowing rate.
Present value of minimum lease payment using lessee’s incremental borrowing rate 10% is computed
below:
Year MLP ₹ DF (10%) PV ₹
1 50,000 0.909 45,450
2 50,000 0.826 41,300
3 50,000 0.751 37,550
4 50,000 0.683 34,150
5 50,000 0.621 31,050
5 25,000 0.621 15,525
2,05,025
Present value of minimum lease payment = ₹ 2,05,025
Fair value of leased asset = ₹ 2,00,000
The accounting entry at the inception of lease to record the asset taken on finance lease in books of lessee
is suggested below:
₹ ₹
Asset A/c Dr. 2,00,000
To Lessor (Lease Liability) 2,00,000
(Being recognition of finance lease as asset and liability)
Since the liability is recognised at fair value ₹ 2 lakh (total principal), we need to ascertain a discounting
rate at which present value minimum lease payments equals ₹ 2 lakh. The discounting rate can then be
used for allocation of finance charge over lease period.
PV of minimum lease payments at guessed rate 12%.
Year Minimum Lease DF (12%) PV ₹