By Karolina Porizkova and Tatiana Alekhina LEASES By Karolina Porizkova and Tatiana Alekhina

Controversy Over Lease Classification and Accounting The basic concept of lease accounting is that some leases are merely rentals, whereas others are disguised purchases. For instance, if you rent office space for a year, the space is worth nearly as much at the end of the year as when you started; you are simply using it for a short period of time. This rental is called an operating lease. If you lease a computer for five years, however, at the end of the lease the computer is nearly worthless. The lessor (the person who receives the rents) anticipates this, and charges the lessee (the person who uses the asset) a rent that will recover all of the lease's costs, with a profit built in. This is essentially a purchase with a loan, which is called a capital lease or finance lease , and an asset and liability must be set up on the lessee's primary financial statements. Rental payments are considered repayments of the loan; depreciation and interest expense, rather than rent expense, are shown on the income statement.

Meaning A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset An operating lease is a lease other than a finance lease.

Objective The objective of this accounting standard is to prescribe for lessees and lessors, the appropriate accounting policies and disclosures in relation to all assets leased that may be finance lease or operating lease. Accounting provided in this AS is based on SUBSTANCE of the transaction rather than on FORM.

EXCLUSIONS AS-19 does not apply to the followings:- (a) Lease agreement for natural resources such as oil, gas, timber, metals and mineral rights. (b) Licensing agreements for items such as motion picture films, video recordings, patents, manuscripts and copyrights. (c) Lease agreement to use land. (d) Agreements for contracts for services that do not transfer the right to use assets. Example- Use of Taxi

FINANCE LEASE A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. INDICATORS OF FINANCE LEASE Transfer of ownership at the end of lease term. Where lessee has purchased the option at very reduced rates and lessee is certain to opt for this purchase option at the inception. Where lease term covers substantial period of economic life of the asset. Where amount paid as lease rentals in terms of P.V. is equal to the fair value of the asset. Where asset is of specialized nature and cannot be used by person other than lessee without making major modifications.

INDICATORS OF FINANCE LEASE Long term lease Where lease transfers substantially all the risks and rewards incidental to ownership. Title may or may not eventually be transferred. Where lease cannot be cancelled or can be cancelled only if the lessor is reimbursed for any losses. Where lessee is required to take the risk of obsolescence. Where cost of maintenance, taxes and insurance are to be incurred by the lessee unless the contract so provide for.

OPERATING LEASE A lease other than a finance lease or where indicators of finance lease do not exist, such type of lease shall be classified as operating lease. INDICATORS OF OPERATING LEASE Short term lease Where lease does not transfer substantially all the lessor. Where the lessee is protected against the risk of obsolescence, risks and rewards incidental to ownership. Where cost of maintenance, taxes and insurance are to incurred by

Accounting treatment for operating lease: From Lessee’s point of view Lease rental paid/payable by lessee should be recognized as an expense on systematic basis. Systematic basis means an expense should be recorded as and when benefits are availed. When systematic basis cannot be identified then straight-line method is used for recording the expenses. From Lessor’s point of view Lease rental received/receivable by lessor should be recognized as an income on systematic basis. If same cannot be identified then straight-line method is used for recording the incomes.

INCOME TAX ISSUES TREATMENT AS PER TAX LAWS Since Income Tax Act does not recognize the concept of Finance lease, therefore, there will be timing difference and an adjustment for deferred tax will be carried out. However, in case of operating lease accounting treatment is same as per tax laws. Hence ,there is no difference TREATMENT AS PER TAX LAWS LEASE RENT Taxable income in the hands of Lessor Lessor will be entitled for depreciation Deductible expenditure in the hands of Lessee

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