In a lease arrangement, the lessor and lessee reach an agreement where the lessee obtains the right to use a particular asset. In return for this, they provide a one-time payment or a set of payments over a specified duration. Accounting Standard AS 19 outlines accounting policies that are generally relevant to all types of leases, with the exception of a few specific lease types, which we shall see in this blog along with the importance of accounting and bookkeeping services.
Types of Leases Excluded from Accounting Standard AS 19
The Accounting Standard AS 19 provides guidelines for accounting treatment in lease agreements. However, there are certain types of leases that are exempt from its scope. These excluded lease categories are as follows:
1. Lease Agreements for Natural Resource Exploration and Utilisation
Accounting Standard AS 19 does not cover lease agreements related to the exploration and utilisation of natural resources such as gas, oil, metals, timber, and mineral rights. The accounting standards for these types of leases may differ due to their unique characteristics and economic considerations.
2. Licencing Agreements
Licencing agreements are not subject to Accounting Standard AS 19. These agreements encompass a wide range of intellectual property, including video recordings, motion picture films, patents, copyrights, plays, and manuscripts. Such agreements have distinct accounting requirements that fall outside the scope of AS 19.
3. Land Lease Agreements
Lease agreements for the use of land are another category not addressed by Accounting Standard AS 19. Land leases have their own accounting standards, which are separate from those applied to leases of other assets. Therefore, they are excluded from the provisions of the said Accounting Standard AS 19.
Types of Leases
Leases are contractual arrangements that allow one party (the lessee) to use an asset owned by another party (the lessor) for a specified period in exchange for periodic payments. There are primarily two types of leases, each with distinct characteristics and accounting treatments:
1. Finance Lease
A finance lease, also known as a capital lease, is a lease in which the lessee essentially assumes the risks and rewards associated with ownership of the leased asset.
2. Operating Lease
An operating lease is a lease arrangement where the lessee does not assume the substantial risks and rewards of ownership. Instead, it is a more straightforward rental agreement.Both finance leases and operating leases serve different purposes and have distinct financial implications. The choice between them depends on factors such as the lessee’s intended use of the asset, risk tolerance, and accounting considerations, including the treatment of the lease on the balance sheet.
What is a Finance Lease?
A finance lease, also known as a capital lease, is characterised by the lessee assuming most of the risks and benefits associated with ownership, even if ownership or title transfer may or may not occur. Mentioned below are some key features and examples of finance leases:
Key Features of Finance Lease
The important Features of finance lease include:
1. Lease Term Equals Asset’s Entire Economic Life: In a finance lease, the lease term typically spans the entire economic life of the asset, regardless of whether ownership or title is transferred.
2. Specialised Property: Finance leases often involve assets of a specialised nature. For example, an ambulance may be leased under a finance arrangement, and the lessee can use it without making significant modifications to the asset.
3. Assets Handed to Lessee: Some finance leases involve the lessor transferring the asset to the lessee at end of the lease term.
4. Full Coverage of Fair Value: The fair value for leased property is also covered fully by the present value of min. Lease payments or equivalent to it.
Disclosure in the Context of Finance Lease
In the context of finance leases, various disclosures are required to provide transparency and clarity in financial reporting. These disclosures typically include:
(i) Total of Minimum Lease Payments and Their Current Value:
– Not Later than 12 Months: Disclose the total of the minimum lease payments that are due within the next 12 months and their present value.
– Later than One Year but Not Later than Five Years: Provide the total of the minimum lease payments due in the period from one year to five years from the balance sheet date, along with their present value.
– Later than Five Years: Disclose the total of the minimum lease payments that are due beyond five years from the balance sheet date and their present value.
(ii) Net Carrying Amount of Leased Assets:
Display what is the net carrying amount for every leased asset as for the balance sheet date. This amount represents the value at which the asset is recognised on the lessee’s balance sheet after accounting for depreciation and lease liability reductions.
(iii) Reconciliation between Minimum Lease Payments and Present Value:
Provide a reconciliation between the minimum lease payments as of the balance sheet date and their present value. This reconciliation should help stakeholders understand how the present value was determined and why it may differ from the nominal minimum lease payments.
What is an Operating Lease?
An operating lease is a lease arrangement where the lessee does not assume most of the risks and rewards of ownership, and it is not classified as a finance lease. Mentioned below are key aspects of operating leases and the respective accounting treatment:
Accounting in Books of the Lessor — In Context of Operating Lease:
For lessors in operating lease arrangements:
(i) Recognise Lease Income: The lessor must recognise the lease income in the statement of profit and loss over the lease term, typically on a straight-line basis, reflecting a steady income pattern.
(ii) Impairment and Provisions: The lessor should periodically examine the leased assets for impairment and make provisions for any expected losses or declines in value.
(iii) Fixed Asset Classification: Assets under operating lease arrangements should be listed under “fixed assets” on the balance sheet of the lessor.
(iv) Expenses and Depreciation: The lessor must include expenses related to the leased asset in the statement of profit and loss, which typically encompass any maintenance and depreciation costs associated with the asset.
Differences Between IFRS 16, IAS 17 and AS 19 in Lease Accounting
Lease accounting standards have evolved over the years, and there are notable differences between IFRS 16, Accounting Standard AS 19, and IAS 17 in terms of how they recognise and account for leases. For this, accounting and bookkeeping services from StartupFino can aid users in their course:
Accounting Standard AS 19:
1. Recognition of Lease: Accounting Standard AS 19 requires the recognition of a lease at the start of the lease term, both for finance and operating leases.
2. Sale and Leaseback Transaction (Finance Lease): In the case of a sale and leaseback transaction involving a finance lease, Accounting Standard AS 19 mandates that the seller (lessee) defers as well as amortises excess of remaining sale proceeds over the carrying price of asset over lease term, and in proportion to what is the depreciation of the leased asset.
IFRS 16:
1. Lease Rentals in Operating Lease: IFRS 16 prescribes that all lease rentals in the case of an operating lease must be recognised as an expense in the profit and loss statement. This is a significant change from IAS 17, where operating lease expenses were not typically recognised as such.
2. Inflation-Linked Lease Rentals: IFRS 16 requires that if lease transactions are structured to increase in line with anticipated rising prices to compensate for the lessor’s expected inflation rate, all lease rentals for operating leases must still be charged to the profit and loss statement unless the changes in lease payments are due to reasons other than normal depreciation. This aligns with the principle of recognising expenses as they are incurred.
IAS 17 (International Accounting Standard 17):
1. Recognition of Lease: IAS 17, similar to AS 19, mandates the recognition of finance leases as assets and liabilities on the balance sheet at the commencement of the lease period.
2. Sale and Leaseback Transaction (Finance Lease): IAS 17, in the case of a sale and leaseback transaction involving a finance lease, requires the seller (lessee) to defer as well as amortise excess sale proceeds above carrying price of asset. However, IAS 17 does not specify the method of amortisation, providing more flexibility to the entity.
Final Thoughts
The accounting standards governing lease transactions, such as IFRS 16, Accounting Standard AS 19, and IAS 17, exhibit notable disparities in their treatment of lease recognition, rental expense recognition, and sale and leaseback transactions. IFRS 16 revolutionises lease accounting by mandating the recognition of operating lease rentals as expenses, aligning with the principle of recognising costs when incurred.
On the other hand, Accounting Standard AS 19 and IAS 17 have a more traditional approach, distinguishing finance and operating leases with specific guidance on sale and leaseback transactions. Ultimately, these standards reflect the ongoing evolution of accounting practices, addressing transparency, balance sheet presentation, and the economic substance of lease agreements, while balancing the distinct needs of businesses, investors, and stakeholders.
