ACCOUNTING STANDARDS

Accounting Standards are written policy documents issued by expert accounting body covering the aspects of recognition measurement, presentation and disclosure of accounting transactions in the financial statements. Accounting Standards deals with the issue of : (1)Recognition of events and transactions in the financial statements. (2)Measurement of these transactions and events. (3)Presentations of these transactions and events in the financial statements in a manner that is meaningful and understandable to the reader. There are 32 accounting standards. Let us get familiar with AS-19. ACCOUNTING STANDARD 19- LEASES A lease is an agreement whereby the lessor conveys to the lessee in return for payment or series of payments the right to use an asset for an agreed period of time. Prior to issuance of AS-19(leases), by the institute of chartered accountants of india, all leases were treated as a mode of offBalance sheet finance. This allowed not to recognize assets taken on lease in their Banlance sheet and thus to understate their net assets and capital employed and consequently to overstate their return on investment.

The AS-19, leases, has reduced the scope of this kind of window dressing by requiring enterprise to recognize assets taken on certain type of asset called finance lease. Types Of Leases: For accounting purposes, leases are classified as : Finance Lease : A Finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. Title may or may not be eventually transferred. Operating Lease : A lease is classified as an operating lease if it does not transfer substantially all the risk and rewards incident to ownership. Non-Cancellable lease: A Non-Cancellable lease is a lease that is cancellable only: a) Upon the occurrence of some remote contingency; or b) With the permission of the lessor; or c) If the lessee enters into new lease for the same or an equivalent asset with the same lessor. d) Upon payment by the lessee of an additional amount such that, at inception, continuation of the lease is reasonably certain. So as of now we have seen types of leases, let us see the situations that would normally lead to a lease being classified as a finance lease:

1. The lease transfers ownership of the asset to the lessee by the end of the lease term. What do you mean by lease term? Ans: The lease term is the non cancellable period for which the lessee has agreed to take on the lease the asset together with any further periods for which the lessee has the option to continue the lease of the asset with or without further payment. 2. The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonable certain that the option will be exercised; What do you mean by fair value? Ans: Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing, Parties in an arms length transaction. What do you mean by Inception of the lease? Ans: The Inception of the lease is the earlier of the date of the lease agreement and the date of commitment by the parties to the principal provisions of the lease. 3. The lease term is for the major part of the Economic life of the asset even if title is not transferred. What do you mean by Economic life of the asset? Ans: Economic life is either : a) The period over which an asset is expected to be economically usable by one or more users; or b) The number of production or similar units expected to be obtained from the asset by one or more users.

c) The leased asset is of a specialized nature such that only the lessee can use it without major modification being made. ACCOUNTING FOR FINANCE LEASEES IN THE BOOKS OF LESEE (1) On the date of inception of lease, lessee should show it as an asset and corresponding liability at lower of : Fair value of leased asset Present value of minimum lease payments. (2) Lease payments to be apportioned between the finance charge and the reduction of the outstanding liability. (3) Finance charges to be allocated to periods during the lease term so as to produce a constant rate of interest on the remaining balance of liability for each period. (4) Charge depreciation on leased asset on the same lines as any othe asset. If there is not certainly that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the lease term. The Interest Rate Implicit in the lease : It is the discount rate that, at the inception of the lease, causes the aggregate present value of : a) The minimum lease payments under a finance lease from the stand point of the lessor; and b) Any guaranteed residual value accruing to the lessor, to be equal to the fair value of the leased asset.

COMPUTATION OF RATE IMPLICIT ON LEASE: Discounting Rate = R% P.A Lease Rents = L1, L2 Ln Lease Periods = n years Guaranteed Residual Value = G.R. Unguaranteed Residual Value = U.G.R. Fair Value at the inception of the lease = F.V. Present Value of MLP= L1/ (1+R) 1 + L2/ (1+R) 2 + Ln / (1+R) n + G.R/ (1+R) n. Present Value of U.G.R= U.G.R/(1+R)n

Recognition of Finance Charge :

Minimum lease payment consists of finance charges and the principals. The Principal components reduce the liability to the lessor. The finance charge components are recognized as expenses in the periods the lease payments are incurred. In analyzing the lease payment a constant periodic rate of interest is used. Where the liability is recognized at present value of minimum lease payments. Where The liability is recognized at fair value, the rate of interest must be determined by trial and error as the discounting rate at which present value of minimum lease payments equals the fair value. Depreciation of leased asset: The depreciation policy for a leased asset should be consistent with that for depreciable assets, which are owned, on the depreciation recognized should be calculated in accordance with AS-6 (Depreciation Accounting). If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the lease term or its useful life which ever is shorter.

Disclosures Made By The Lessee:

The lessee should in addition to the requirements of AS-10 and AS-6 and the governing statute, make the following disclosures for finance leases: a) Assets acquired under finance lease are segregated from the assets owned. b) For each class of assets, the net carrying at the balance sheet date.

c) Contingent rents recognized as expense in the statement of profit and loss for the period. d) The total of future minimum subleases payments expected to be received under non-cancellable subleases at the balance sheet date.

Accounting For Finance Lease In The Books Of lessor

In the books of lessor, the finance lease is to be treated as receivables at an amount equal to net investment in the lease. Net investment in the lease is gross investment in lease less unearned finance income. The lease incomes are to be recognized in the P&L based on pattern reflecting constant periodic return. In case of operating lease, the leased asset should be recorded as an asset. Lease income should be recognized in the P&L using straight line method. Some manufacturer undertakes leasing activity also. In case of finance lease by manufacturers, the selling profit is to be recognized immediately. Finance income is to be spread over the period of lease.

Treatment of Initial Direct Cost

PARTY LESSEE(S) LESSOR(S) Being manufacturer or dealer. ALL OTHER LESSOR FINANCE LEASE CAPITALIZE CHARGE CHARGE OR DEFFERED OVER LEASE PERIOD ON PROPORTION OF FINANCE CHARGES. OPERATING LEASE CHARGE CHARGE CHARGE OR DEFFERED OVER THE LEASE PERIOD IN PROPORTION OF RECOGNITION OF RENTAL INCOME.

SALE AND LEASE BACK:

The Basis of sale & lease back agreement is simply that one sells an asset for cash and then leases it back from the buyer. The asset subject to such sale and lease back agreement is generally property. Under such an agreement the property owner agrees to sell the property at an agreed valuation and lease it back from the buyer. The accounting treatment of a sale and lease back depends upon the type of lease involved. Accounting treatment pf profit & loss on sale of asset, as required by the standard in respect of sale and lease back are summarized below: Where sale and leaseback results in finance lease: The excess or shortage of sales proceeds should be deferred and amortized over the lease term in proportion to the depreciation of leased asset. Where sale and leaseback transaction is operating lease: If the fair value at the time of sale and leaseback transaction is less than the carrying amount of the asset, a loss equal to the amount of the difference between the carrying amount and the fair value should be recognized immediately (Paragraph 50). After recognition of loss if any, the profit and loss on sale should be treated in the manner required by Paragraph 50: The Requirements are: 1. Sale Price=Fair Value: Profit or loss should be recognized immediately.

2. Sale Price<Fair value: Profit should be recognized immediately. The loss should also be recorded immediately except that, if the loss is compensated by the 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. 3. Sale Price>Fair Value: The Excess over the fair value should be deferred and amortized over the period for which the asset is expected to be used. Disclosure Aspects Include: 1) In the books of lessee: Finance charges/Lease Payments recognized in the P&L. Re-Conciliation between MLP & P.V on balance Sheet date. Liability is to be disclosed separately as long term and current liability. 2) In the books of lessor: Reconciliation between gross investments in P.V of MLP. Unearned finance income. Unguaranteed residual value. Total accumulated provision for uncollectible lease receivables. 3) Common Disclosures: Age wise break up (0-1 year, 1-5 years, more than 5 years) of gross investment, P.V of MLP. Significant terms under lease agreement. Contingent rent if any in P&L. Accounting Policy recognized/adopted for initial direct cost.

ACCOUNTING FOR OPERATING LEASES: In the books of lessee:

Lease payments are frequently tailor made to suit the payment capacity of the lessee. For example, a lease term may provide for low initial rent. Such payment patterns do not reflect the pattern of benefit derived by the lessee from the use of leased asset. To have better matching between revenue and costs, paragraph 23 of the standard requires lessees to recognize operating lease payments as expense in his statement of profit and loss on a straight line basis over the lease term. Disclosures by lessees: The Paragraph 25 requires lessee to make following disclosures for operating leases: 1) The total future minimum lease payments under non cancelable operating lease for each of the following periods: a) Not later than one year; b) Later than one year and not later than five year; c) Later than five year. 2) The total future minimum sublease payments expected to be received under non cancellable subleases at the balance sheet date. 3) Lease payments recognized in the statement of profit and loss for the period, with separate amounts for minimum lease payment and contingent rents. 4) Sub lease payments received/receivable recognized in the statement of P&L for the period. Note: The level 2 and level 3 enterprises need not make disclosures required by paragraph 25(a), (f), and (e).

 In the books of lessor: Paragraph 39 requires a lessor to treat assets given under operating leases as fixed assets in the balance sheet. Paragraph 41 requires depreciation to be recognized in the books of lessor. The impairment losses on assets given on operating leases determined and treated as per AS-28. A manufacturer or a dealer lessor should bring the asset given on operating lease as fixed asset in their books by debiting concerned fixed assets a/c and crediting cost of production at cost. No selling profit should be recognized because such leases are not equal of sale.

DIAGRAMATIC REPRESENTATION LEASE Convey right to use an asset. In payment or series of payments. For an agreed period of time. Includes hire purchase agreements.
Classify at the inception of the lease as: Finance Lease Consider Substance over Form Substantially transfer all Risks & rewards incident to ownership. Operating Lease Other than finance lease. Negative definition.

MINIMUM LEASE PAYMENTS Total lease rent guaranteed residual value, or Total lease rent payment on purchase option. In the books of lessee: Recognize as asset and liability. Initial recognition of asset at lower of F.V and P.V of MLP. Charge lease payments to P&L. Provide depreciation as per AS-6. In the books of lessee: Recognize lease payments. Pattern-Straight line basis over the lease term.

In The books of lessor: Recognize as receivables at an amount equal to net investment in the lease. Recognize lease income in P&L. Pattern-Constant periodic return.

In the books of lessor: Recognize as asset. Recognize lease income in P&L using straight line method. Charge depreciation as per AS-6.

DISCLOSURE Details of leasing agreement. Accounting policy for initial direct cost. Age wise break up of gross investment PV of MLP: o Up to 1 year. o > 1 year 5 years. o > 5 year.