Chapter 3

Accounting/Reporting
Framework and Taxation of
Leasing
1

Accounting/Reporting
An appropriate method of accounting is
necessary for income recognition for the lessor
and asset disclosure for the lease. Recognising
the need for a proper accounting system for
lease transactions, IAS-17 was issued in 1982.
The ICAI issued a guidance note in 1988 which
favoured the adoption of IAS-17 in the long run
but recommended for the interim period a set of
accounting guidelines in the context of the
2

state of leasing industry in India and the incometax framework. However, due to court
intervention its recommendatory character was
kept in abeyance. After judicial pronouncement,
the ICAI Revised Guidances Notes was issued in
September 1995. The Reserve Bank of India
constituted a study group on the guidance note
and on its recommendations made it compulsory
on the leasing companies. The ICAI issued the
AS-1 9: Lease based on IAS-1 7 in January 2001.

IAS-17 FRAMEWORK
According to the IAS-17, in case of operating
lease, the lease has to allocate the aggregate
lease rental over the lease term on straight line
basis or any other systematic basis which better
reflects the pattern of the timing of the benefit of
the use of the equipment to the lessee (user).
Finance lease should be shown in the balance
sheet of lessee as an asset to properly account
for the economic resources and as a liability
4

to
reflect
stipulates that

the level of its obligations. It

The asset and liability should be recorded at

the inception of the lease at an amount equal
to the fair market value of the asset or the
present value of the minimum lease payment
whichever is lower;
The lease rentals should be apportioned into
interest and capital components using the
effective rate of interest/actuarial method or
any other acceptable approximation (e.g., sum
of the years digits);
5

 The interest/finance
expensed;

charge

should

be

The leased asset should be depreciated in line

with the depreciation policy of the firm in
respect of owned asset. It must be fully
depreciated over the lease term or the useful
life whichever is shorter.

As regards the lessor, the IAS-17 guidelines

require that a finance lease should be recorded
as a receivable in his books equal to the net
investment in lease; that is, gross investment in
lease minus unearned finance income. The
unexpired finance income should be allocated
according to effective rate of interest method to
the relevant accounting period.

Illustration 3.1 (Finance Lease: In the Books of the Lessee)

Assume the Hypothetical Manufacturers Ltd (HML) has entered into a lease agreement for an
equipment costing Rs 750 lakh. The lease is non-cancellable for a period of five years. The annual
lease rentals payable in arrears amount to Rs 300/Rs 1,000. The economic life of the equipment is
expected to be eight years. The HML uses written down value method and 30 per cent rate to
depreciate the equipment. The incremental borrowing rate is 16 per cent and the HML is in tax bracket
of marginal rate of 35 per cent.
From the foregoing information
(A) Determine the capitalised value of the equipment and pass the relevant journal entries for
capitalisation,
(B) Prepare a schedule showing the allocation of unexpired finance charge,
(C) Prepare all relevant ledger accounts for the first three years of the lease. Also, show how the
ledger balances will be reflected in the financial statements,
(D) If incremental borrowing rate is 14 per cent, compute the capitalised value of the equipment and
prepare the schedule showing the allocation of the unexpired finance charge assuming (1)
effective rate of interest method/actuarial method, (2) sum-of-years digits method and (3) straight
line method.
Solution
(A)
Capitalised Value of the Equipment and Journal Entries
(Rs lakh)
_______________________________________________________________________________________________
Fair market value of the equipment
(a)
750.00
Present value of the minimum lease payment (750 0.30) PVIFA (16,5)
(b)
736.70
Capitalised value [as (b) < (a)]
736.70
Journal entry for capitalisation:
Lease equipment A/c
Dr
736.70
To Lease payable A/c
736.70
_______________________________________________________________________________________________

(B)

Allocation of Unexpired Finance Charge [Actuarial/Effective Rate of Interest Method*]

(Rs lakh)
_______________________________________________________________________________________________
Year
Outstanding
Rate of
Interest
Lease
Principal
lease liability
interest (percent)
charge
payment
[(Rs 300 Rs 1,000)
Rs 750 lakh]
_______________________________________________________________________________________________
(A)
(B)
(C)
(D)
(E)
[(A) x (B)]
[(D) (C)]
_______________________________________________________________________________________________
1
736.7
0.16
117.9
225
107.1
2
629.6
0.16
100.7
225
124.3
3
505.3
0.16
80.8
225
144.2
4
361.1
0.16
57.8
225
167.2
5
193.9
0.16
31.0
225
194.0
_______________________________________________________________________________________________
*Note: According to the IAS-17, the unexpired finance charge must be allocated to each accounting period
according to the actuarial/effective rate of interest method. According to this method of allocation, the
unexpired finance charge must be allocated to each accounting period so as to produce a constant periodic
rate of interest on the balance of the liability during each accounting period.
Unexpired finance charge = (Rs 750 0.30 5) Rs 736.70 = Rs 388.3 lakh

(C) Ledger Accounts

Leased Equipment A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Lease Payable A/c
736.70
1
By Balance c/d
736.70
2
To Balance b/d
736.70
2
By Balance c/d
736.70
3
To Balance b/d
736.70
3
By Balance c/d
736.70
_______________________________________________________________________________________________
Accumulated Depreciation A/c@
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
2

To Balance c/d
To Balance c/d

221.0
375.7
_____
375.7
484.0

1
2

By Depreciation A/c
By Balance b/d
By Depreciation A/c

221.0
221.0
154.47
375.7
3
To Balance b/d
3
By Balance b/d
357.7
By Depreciation a/c
108.3
484.0
484.0
_______________________________________________________________________________________________
@ Working note 1 for depreciation schedule.

10

Depreciation A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Accumulated depreciation A/c
221.0
1
By Profit and loss A/c
221.0
2
To Accumulated depreciation A/c
154.7
2
By Profit and loss A/c
154.7
3
To Accumulated depreciation A/c
108.3
3
By Profit and loss A/c
108.3
_______________________________________________________________________________________________
Lease Rental A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Bank A/c
225.0
1
By Lease payable A/c
107.1
_____
By Finance charges A/c 117.9
225.0
225.0
2
To Bank A/c
225.0
1
By Lease payable A/c
124.3
_____
By Finance charges A/c 100.7
225.0
225.0
3
To Bank A/c
225.0
1
By Lease payable A/c
144.2
_____
By Finance charges A/c 80.8
225.0
225.0
_______________________________________________________________________________________________

11

Finance Charges A/c

_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
1
To Lease rental A/c
117.9
1
By Profit & Loss A/c
117.9
2
To Lease rental A/c
100.7
2
By Profit & Loss A/c
100.7
3
To Lease rental A/c
80.7
3
By Profit & Loss A/c
80.8
_______________________________________________________________________________________________
Lease Payable A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Lease rental A/c
107.1
1
By Leased equipment A/c
730.7
To Balance b/d
629.6
736.7
2
To Lease rental A/c
124.7
2
By Balance c/d
629.6
To Balance c/d
505.3
629.6
3
To Lease rental A/c
144.2
3
By Balance c/d
505.3
To Balance c/d
361.1
505.3
_______________________________________________________________________________________________

12

Disclosure in the Financial Statements

Year 1:
Profit and Loss A/c
_______________________________________________________________________________________________
Amount
(Rs lakh)
_______________________________________________________________________________________________
To Finance charges
117.9
To Depreciation
221.0
_______________________________________________________________________________________________
Balance Sheet
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Secured loans
Fixed assets
Lease payable
505.3
Leased equipment: Gross block
736.7
Current liabilities
Lease payable
124.3
Less: Accumulated depreciation
221.0
Net block
515.7
_______________________________________________________________________________________________

13

Notes to Accounts: The commitments for minimum lease payments under the finance lease are as follows:
_______________________________________________________________________________________________
Year
Lease payment (Rs lakh)
_______________________________________________________________________________________________
2
225
3
225
4
225
5
225
_______________________________________________________________________________________________
Year 2:
Profit and Loss A/c
_______________________________________________________________________________________________
Amount
(Rs lakh)
_______________________________________________________________________________________________
To Finance charges
100.7
To Depreciation
154.7
_______________________________________________________________________________________________
Balance Sheet
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Secured loans
Fixed assets
Lease payable
361.1
Leased equipment: Gross block
736.7
Current liabilities
Less: Accumulated depreciation
375.7
Lease payable
144.2
Net block
361.0
_______________________________________________________________________________________________

14

Notes to Accounts: The commitments for minimum lease payments under the finance lease are as follows:
_______________________________________________________________________________________________
Year
Lease payment (Rs lakh)
_______________________________________________________________________________________________
3
225
4
225
5
225
_______________________________________________________________________________________________
Year 3:
Profit and Loss A/c
_______________________________________________________________________________________________
Amount
(Rs lakh)
_______________________________________________________________________________________________
To Finance charges
80.8
To Depreciation
108.3
_______________________________________________________________________________________________
Balance Sheet
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Secured loans
Fixed assets
Lease payable
193.9
Leased equipment: Gross block
736.7
Current liabilities
Less: Accumulated depreciation
484.0
Lease payable
167.2
Net block
252.7
_______________________________________________________________________________________________

15

Notes to Accounts: The commitments for minimum lease payments under the finance lease are as follows:
_______________________________________________________________________________________________
Year
Lease payment (Rs lakh)
_______________________________________________________________________________________________
4
225
5
225
_______________________________________________________________________________________________
It may be noted that the depreciation charge and finance charge for each accounting period do not add up to
the leased rentals payable for that period. Therefore, the values of the leased assets and the corresponding
liability are unlikely to equal after the inception of the lease.
(D) Computation of Capitalised Value
(1) The minimum lease payment (MLP) (c) = (Rs 750 0.30) PIFA (14,5) = Rs 225 3.433 = Rs 772.4 lakh
Capitalised value [as (a) i.e. fair market value of the asset of Rs 750 lakh is less than (c) i.e.
MLP]
= Rs 750 lakh
or
PVIFA (r, 5) = 3.333
r = 15.24 per cent
Allocation of Unexpired Finance Charge: Actuarial Method
(Rs lakh)
_______________________________________________________________________________________________
Year
Outstanding
Rate of
Interest
Lease
Principal
lease liability
interest (percent)
charge
payment
_______________________________________________________________________________________________
1
750.0
0.1524
114.3
225
110.7
2
639.3
0.1524
97.4
225
127.6
3
511.7
0.1524
78.0
225
147.0
4
364.7
0.1524
55.6
225
169.4
5
195.3
0.1524
29.7
225
195.3
_______________________________________________________________________________________________

16

Allocation of Unexpired Finance Charge: Sum of Years Digits Method

(Rs lakh)
_______________________________________________________________________________________________
Year
Total finance charge
Weightage
Allocated charge
to be allocated
_______________________________________________________________________________________________
1
383.3
5/15
129.4
2
383.3
4/15
103.5
3
383.3
3/15
77.7
4
383.3
2/15
51.8
5
383.3
1/15
25.9
_______________________________________________________________________________________________
Note: The denomination 15 is the sum of (1 + 2 + 3 + 4 + 5).
Allocation of Unexpired Finance Charge: Straight Line Method
_______________________________________________________________________________________________
Year
Allocated charge (Rs lakh)
_______________________________________________________________________________________________
1
77.7
2
77.7
3
77.7
4
77.7
5
77.7
_______________________________________________________________________________________________
According to IAS-17, the finance charge should be allocated according to the actual/effective rate of interest
method. However, for simplified computations, some form of approximation is also allowed. The sum of digits
method provides such an approximation.

17

Working Notes
1.
Depreciation Schedule (@ 30% on WDV basis)
_______________________________________________________________________________________________
Year
Depreciation charge
Amount (Rs lakh)
_______________________________________________________________________________________________
1
736.7 0.30
221.0
2
736.7 (1.0.3) 0.3
154.7
3
736.7 (1.0.3)2 0.3
108.3
4
736.7 (1.0.3)3 0.3
75.8
5
736.7 (1.0.3)4 0.3
51.3
_______________________________________________________________________________________________
2.

As per the requirements of IAS-17, the portion of the lease payable which falls due for payment in the
next accounting period has been classified as a current liability at the end of each accounting period.

18

Illustration 3.2 [Finance Lease: In the Books of the (Third Party) Lessor]
For the foregoing facts relating to the Hypothetical Manufacturers Ltd (HML), assume that the lease
under consideration is structured by the Hypothetical Leasing Ltd (HLL). The direct cost of setting up
the lease transaction is estimated to be Rs 7.50 lakh. The unguaranteed residual value of the asset at
the end of five years is expected to be Rs 37.5 lakh.
You are required to:
(A) Prepare a schedule showing the allocation of the respective unearned finance income;
(B) Show ledger accounts for the first three years of lease. Also prepare the financial statements for
the respective periods.
Solution
1.
Allocation of Unearned Finance Income: Actuarial Method
(Rs lakh)
_______________________________________________________________________________________________
Year
Outstanding
Rate of
Interest
Lease
Principal
lease liability
interest (percent)
charge
payment
_______________________________________________________________________________________________
(1)
(2)
(3) [(1) x (2)]
(4)
(5) [(4) (3)]
_______________________________________________________________________________________________
1
750.0
0.1612
120.9
225.0
104.1
2
645.9
0.1612
104.1
225.0
120.9
3
525.0
0.1612
84.6
225.0
140.4
4
384.6
0.1612
62.0
225.0
163.0
5
221.6
0.1612
35.7
225.0
221.6
_______________________________________________________________________________________________
Working Notes
1. Interest rate, r, implicit in the lease transaction = (Rs 750 0.30 12) PVIFA (r, 5) + [32.5 PVIF
(r, 5)] = Rs 750 = 16-17%, by interpretation = 16.12 per cent
2. Unearned finance income = Rs [(750 0.30 5) + 32.5 750] lakh = Rs 407.5 lakh

19

2. Ledger Accounts
Gross Investment in Lease A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Inventory A/c
750.0
1
By Bank A/c
225.0
To Unearned finance income A/c
407.5
By Balance
932.5
1,157.5
1,157.5
2
To Balance b/d
932.5
2
By Bank A/c
225.0
_____
By Balance c/d
707.5
932.5
932.5
3
To Balance b/d
707.5
3
By Bank A/c
225.0
_____
By Balance c/d
482.5
707.5
707.5
_______________________________________________________________________________________________
Unearned Finance Income A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Finance income A/c
120.9
1 By Gross investment in lease A/c 407.5
To Balance c/d
286.6
_____
407.5
407.5
2
To Finance income A/c
104.1
2 By Balance b/d
286.6
To Balance c/d
182.5
_____
286.6
286.6
3
To Finance income A/c
84.6
3 By Balance b/d
182.5
To Balance c/d
97.9
_____
182.5
182.5

20

Finance Income A/c

_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Profit and loss A/c
120.9
1
By Unearned finance income A/c
120.9
2
To Profit and loss A/c
104.1
2
By Unearned finance income A/c
104.1
3
To Profit and loss A/c
84.6
3
By Unearned finance income A/c
84.6
_______________________________________________________________________________________________
Initial Direct Cost A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Bank A/c
7.5
1
By Profit and loss A/c
7.5
_______________________________________________________________________________________________
3. Disclosure in the Financial Statements
Year 1:
Dr.
Profit and Loss A/c
Cr.
_______________________________________________________________________________________________
Amount
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
To Initial direct costs
7.5
By Finance income
120.9
_______________________________________________________________________________________________

21

Balance Sheet
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Current assets:
Net investment in lease
(1,157.5 407.5 104.1)
645.9
_______________________________________________________________________________________________
Year 2:
Profit and Loss A/c
_______________________________________________________________________________________________
Amount
(Rs lakh)
_______________________________________________________________________________________________
By Finance income
104.1
_______________________________________________________________________________________________
Balance Sheet
_______________________________________________________________________________________________
Liabilities
Assets
Amount
(Rs lakh)
_______________________________________________________________________________________________
Current assets:
Net investment in lease
(645.9 120.9)
525.0
_______________________________________________________________________________________________

22

Year 3:
Profit and Loss A/c
_______________________________________________________________________________________________
Amount
(Rs lakh)
_______________________________________________________________________________________________
By Finance income
84.6
_______________________________________________________________________________________________
Balance Sheet
_______________________________________________________________________________________________
Liabilities
Assets
Amount
(Rs lakh)
_______________________________________________________________________________________________
Current assets:
Net investment in lease
(525.0 140.4)
384.6
_______________________________________________________________________________________________
Note: The recognition of finance income here is based on the net investment in lease, that is, the gross
investment in lease less the unearned finance income.
In some special types of leasing, for example, leveraged lease, where the lessor finances the cost of
acquisition through a mix of own funds and non-recourse long-term debt, the basis for recognising finance
income is the net cash investment in lease, that is, net investment in lease less the non-recourse debt. Since
the patterns of income recognition based on the net investment and the net cash investment are likely to differ
significantly, according to IAS-17 the chosen basis must be applied consistently to leases of the same
financial nature.

23

Illustration 3.3 (Finance Lease in the Books of Manufacturer/Dealer-Lessor)

Assume that the Hypothetical Manufacturers Ltd (HML) is a dealer-lessor in industrial machinery. It sells its
products on the basis of a 5-year non-cancellable lease. The cash price of the machinery is 36 lakh inclusive of
a 25 per cent margin on cost. The lease rate is Rs 240/Rs 1,000. The rentals are payable annually in advance.
The unguaranteed residual value of the machinery at the end of the lease period is estimated to be Rs1.80
lakh. The market rate of interest may be assumed to be 15 per cent per annum.
You are required to:
(i)
Determine the sale revenue to be recognised under the finance lease proposal,
(ii)
Show the allocation of the finance income,
(iii)
Show the necessary ledger accounts for the first year of the lease as also the financial statements
at the end of the first year.
Solution
(a)
Determination of Sales Revenue
(i) Annual lease rental = Rs 36 lakh 0.24 12 = Rs 10.38 lakh
Present value of advance annual lease rent plus the unguaranteed estimated residual value
= [Rs 10.38 lakh PVIFA (15, 5)] + [Rs 1.80 lakh PVIF (15, 4)] = Rs 40.92 lakh
(ii) Fair market value = Rs 36 lakh
Since (ii) < (i), the recorded sales revenue = Rs 36 lakh
(b)
Allocation of Unearned Finance Income: Actuarial Method
(Rs lakh)
_______________________________________________________________________________________________
Year
Outstanding
Rate of
Interest
Capital
Lease
investment at
interest
content
content
receipts
the beginning
_______________________________________________________________________________________________
1
36.00
0.2392
8.58
4.26
12.84
2
32.34
0.2392
7.56
5.28
12.84
3
26.46
0.2392
6.30
6.54
12.84
4
19.92
0.2392
6.54
6.30
12.84
5
11.82
0.2392
2.82
11.82
14.64
_______________________________________________________________________________________________

24

Working Notes
The rate of interest implicit in the proposal,
r=
[10.38 PVIFA (r, 5)] + [1.80 PVIF (r, 5)] = 36
Or [10.38 (1 + r) PVIFA (r, 5)] + [1.80 PVIF (r, 5)] = 36 = 2.392% (by trial and error and interpolation).
Unearned finance income = [(Rs 10.38 lakh 5) + Rs 1.80 lakh] Rs 36 lakh = Rs 17.70 lakh
Annual lease rental (in arrear) =
(Rs 10.38 lakh 1.2392) = Rs 12.84 lakh
Since the lease rentals are received annually in advance, the annual lease rentals must be adjusted for an
interest rebate of Rs 2.46 lakhs (= 12.84 10.83). The allocation of the unearned finance income after effecting
this adjustment is shown in Table 3.1.
Table 3.1 Allocation of Unearned Finance Income (Rs lakh)
_______________________________________________________________________________________________
Year
Outstanding investment
Interest
Capital
Lease
at the beginning
content
content
related receipts
_______________________________________________________________________________________________
1
36.00
6.12
4.26
10.38
2
32.34
5.10
5.28
10.38
3
26.46
3.84
6.54
10.28
4
19.92
2.28
8.10
10.38
5
11.82
0.36
11.62
11.98
_______________________________________________________________________________________________
(c) Ledger Accounts
Cost of Goods Sold A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Inventory A/c (36 0.80)
28.80
1
By Profit and loss A/c
28.80
_______________________________________________________________________________________________

25

Finance Income A/c

_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
1
To Profit and loss A/c
6.12
1
By Unearned finance income A/c
6.12
_______________________________________________________________________________________________
Disclosure in the Financial Statements:
Profit & Loss A/c
_______________________________________________________________________________________________
Year
Amount
Year
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
To Cost of goods sold
28.80
By Sales income
36.00
By Finance income
6.12
_______________________________________________________________________________________________
Balance Sheet
_______________________________________________________________________________________________
Liabilities
Assets
Amount
(Rs lakh)
_______________________________________________________________________________________________
Current assets:
32.34
Net investment in lease (36 4.26)
_______________________________________________________________________________________________

26

Illustration 3.4 (Operating Lease)

The Hypothetical Manufacturers Ltd (HML) acquires a machine on a 3-year operating lease from the
Hypothetical Leasing Ltd (HLL). The following details are available:
(Rs lakh)
_______________________________________________________________________________________________
Cost of equipment
48.000
Assumed rental charges: Year
1
14.688
2
14.112
3
13.536
_______________________________________________________________________________________________
The lease rentals are to be paid in arrear. The HML depreciates plant and machinery on straight line basis @ 10
per cent per annum. Show the recording of the transactions in the books of HML (lessee).
Solution

Computation of Rentals: Straight Line Basis

(Rs lakh)
_______________________________________________________________________________________________
Year
1
2
3
_______________________________________________________________________________________________
(A)
Rental paid
14.688
14.112
13.536
(B)
Rental prepaid during the previous year

0.576
0.576
(C)
Rental expense for the year
14.112
14.112
14.112
(D)
Rental prepaid for the year (A + B + C)
0.576
0.576
Nil
_______________________________________________________________________________________________

27

Record in Financial Statements

Year 1:
Income Statement
(Rs lakh)
_______________________________________________________________________________________________
Rental expenses
14.112
_______________________________________________________________________________________________
Balance Sheet
(Rs lakh)
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Current assets:
Prepaid lease rental
0.576
_______________________________________________________________________________________________
Year 2:
Income Statement
(Rs lakh)
_______________________________________________________________________________________________
Rental expenses
14.112
_______________________________________________________________________________________________
Balance Sheet
(Rs lakh)
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Current assets:
Prepaid rental
0.576
_______________________________________________________________________________________________

28

Balance Sheet
(Rs lakh)
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Current liabilities:
Fixed assets
Rental received in advance
0.576
Assets on Lease:
Gross block
48.00
Less: Accumulated depreciation
9.60
38.40
_______________________________________________________________________________________________
Year 3:
Income Statement
(Rs lakh)
_______________________________________________________________________________________________
Depreciation on
4.80
Rental income
14.112
_______________________________________________________________________________________________
Balance Sheet
(Rs lakh)
_______________________________________________________________________________________________
Liabilities
Amount
Assets
Amount
(Rs lakh)
(Rs lakh)
_______________________________________________________________________________________________
Fixed assets
Assets on Lease:
Gross block
48.00
Less: Accumulated Depreciation 14.40
33.60
_______________________________________________________________________________________________

29

AS-19: Framework
According to AS-19, the lessee should recognise
the finance lease as an asset and a liability at an
amount equal to the lower of the fair value of the
leased asset or the present value of the minimum
lease payments using the interest implicit in the
lease/incremental borrowing rate of the lessee as
the discount factor. The lease payments should
be apportioned between finance charge
and
the reduction in the outstanding liability. The
30

finance charge should be allocated to periods

during the lease term so as to produce a constant
periodic rate of interest on the remaining balance
of the liability for each period. The depreciation
policy for a leased asset should be consistent
with that for owned assets. The asset should be
fully depreciated over the lease term or its useful
life whichever is shorter.

31

The lessor should recognise assets given under

a finance lease in its balance sheet as
receivables at an amount equal to the net
investment in the lease. The recognition of
finance income should be based on a pattern
reflecting a constant periodic rate of return on
the net investment of the lessor outstanding in
respect of the finance lease. The manufacturerdealer lessor should recognise the transaction of
sale and selling profit/loss in accordance with
policy followed for outright sales. Initial direct
costs should be recognised as a expense at the
inception of the lease.
32

The assets given on operating lease by a lessor

should be shown under fixed assets. Lease
income should be recognised on straight line
basis or other systematic basis representing the
time pattern in which the benefit derived is
diminished.

33

The depreciation of leased assets should be on a

basis consistent with the normal depreciation
policy for similar assets.

34

If a sale and lease back transaction results in a

finance lease, any excess/deficiency of sale
proceeds over the carrying amount should not be
immediately recognised as income/loss by a
seller-lessee but deferred/amortised over the
lease term. If it results in an operating lease
established at a fair value, any profit/loss should
be recognised immediately. If the sale price is
below fair value, profit/loss should be recognised
immediately. However, if the loss is compensated
by future lease payments at below market price, it
should be deferred/amortised in proportion to the
35

lease payments over the period the asset is

expected to be used. The excess of sale price
over fair value should be amortised. If the fair
value at the time of a sale and lease back
transaction is less than the carrying amount of
the asset, a loss equal to the difference should be
recognised immediately.

36

Taxation
The tax aspects of leasing pertain to both income
tax and sales tax.

37

Income Tax
Leasing, as a finance device, has income tax
implications for, and offers tax benefits both to,
the lessor and the lessee. The main attraction of
leasing device to the lessor is the deduction from
his taxable income. The lease rental income of
the lessor is included under the head Profits and
Gains of Business and Profession for the
purpose of assessing the income-tax liability.
While computing the income from leasing,
38

deprecation on the leased asset is allowed as a

deduction to determine the taxable income.
Depreciation claim by the lessor, thus, involves
tax shield on the leased asset. The deductability
of depreciation on leased assets is not explicitly
provided by the Income Tax Act but is deduced
from rulings by courts and appellate tribunals
which accept that the leased assets are deemed
to be used in the lessor's business of leasing of
assets. However, other than the shield on
depreciation, the lessor is not eligible for any
other investment-related tax-shield.
39

The income tax considerations for the lessees

are claims for lease rentals and the operating
costs of the leased assets being treated as
deductible expenses from taxable income. The
lease rentals and the incidental expenses such as
repairs and maintenance, insurance and finance
charge are treated as normal business
expenditure.

40

Leasing can be used as a tax planning device by

(1) exploiting the flexibility in structuring lease
rentals, or (2) transferring the investment-related
tax shield from a firm which has low capacity to
absorb such tax shields to a lessor who can
absorb them. Through such transfer of
unabsorbed capital allowance to the lessor, the
firm transferring the tax shields can benefit
through a reduction in the lease rentals.

41

Sales Tax
A lease transaction attracts sales tax at three
stages: (1) purchase of equipment by the lessor,
(2) transfer of the right to a lessee to use the
equipment for a lease rental and (3) sale of asset
by the lessor at the end of the lease period.

42