AS 19 Leases: formula sheet

Key formulas

Finance lease: general test

Substantially all risks and rewards of ownership transfer to lessee → finance lease; otherwise → operating lease

Classification is by substance and made at inception of the lease.

Situations that would normally lead to a finance lease

(a) Ownership transfers to lessee by end of lease term; (b) lessee has a purchase option at a price sufficiently below fair value, reasonably certain to be exercised; (c) lease term covers a major part of the asset's economic life; (d) PV of MLP at inception amounts to substantially all of the asset's fair value; (e) asset is so specialised that only the lessee can use it without major modification

These situations would normally lead to a finance lease, but no single one is conclusive. Judge the overall substance. AS 19 gives no percentages for 'major part' or 'substantially all'.

Other indicators of a finance lease

Lessee can cancel but bears lessor's losses; gains or losses from changes in residual fair value go to lessee; lessee can renew for a secondary period at a rent much lower than market

These can also lead to a finance lease, even if they are not in the main list.

Minimum lease payments: lessee's view

MLP = Rentals over lease term (excluding contingent rent, service costs, and taxes reimbursed to lessor) + residual value guaranteed by lessee or a party related to him

If a bargain purchase option is reasonably certain, also include the price to exercise it.

Minimum lease payments: lessor's view

MLP = Rentals over lease term (same exclusions) + residual value guaranteed to lessor by lessee, a party related to lessee, or a financially capable independent third party

The lessor's MLP can be higher than the lessee's because third-party guarantees count for the lessor only.

Gross investment in the lease

Gross investment = Lessor's MLP + unguaranteed residual value

Used by the lessor in finance lease accounting.

Interest rate implicit in the lease

PV of (lessor's MLP + unguaranteed residual value) = fair value of the leased asset at inception

The implicit rate is the discount rate at which the aggregate PV of the MLP and the unguaranteed residual value, measured from the lessor's view, equals the fair value of the asset at inception. A lessee who cannot determine the implicit rate uses its incremental borrowing rate. For the classification test, use the MLP of the party whose books you are in. The lessee's test compares the PV of the lessee's MLP with fair value, discounted at the implicit rate or, if that cannot be determined, at the lessee's incremental borrowing rate. The lessor's test compares the PV of the lessor's MLP with fair value, discounted at the implicit rate. Do not apply the lessor's MLP in the lessee's test.

Initial recognition amount

Asset = Liability = Lower of (Fair value, PV of MLP) at inception

Add the lessee's initial direct costs to the asset value only, not to the liability.

Minimum lease payments (lessee)

MLP = Lease rentals over the lease term + Residual value guaranteed by the lessee (or a party related to the lessee), limited to the amount guaranteed + Bargain purchase option price (where exercise is reasonably certain)

Only the amount actually guaranteed is included, not the full expected residual value. Unguaranteed residual value is not part of the lessee's MLP. Contingent rent and executory costs (such as insurance, maintenance) are excluded.

Present value

PV = Σ [Payment ÷ (1 + r)^n]

r is the implicit rate in the lease, or the lessee's incremental borrowing rate if the implicit rate cannot be determined.

Finance charge for a period

Finance charge = Opening outstanding liability × Rate

Gives a constant periodic rate on the remaining balance. This is the layout for payments at year end. For payments in advance, use the separate advance-payment layout in the next formula.

Liability reduction (payments at year end)

Principal repaid = Lease payment − Finance charge; Closing liability = Opening liability + Finance charge − Payment

Use this five-column layout (opening liability, finance charge, payment, principal repaid, closing liability) only when payments fall at the end of each period.

Advance-payment table (payments at start of period)

Balance = Opening liability − Payment at start; Finance charge = Balance × Rate; Closing liability = Balance + Finance charge

The payment made at the start of a period is entirely principal, because no finance charge has accrued on that date. This is a different layout from the year-end table. The closing liability is the amount outstanding before the next advance payment.

Depreciation

Depreciation = (Recognised asset value − Expected residual value) ÷ Period

Period is the useful life if ownership is reasonably certain to pass, otherwise the shorter of lease term and useful life.

Gross investment

Gross investment = Minimum lease payments (lessor's view) + Unguaranteed residual value

Minimum lease payments from the lessor's view = rentals over the lease term + residual value guaranteed (by lessee or a capable third party). Contingent rent and service or tax costs paid for the lessor are excluded.

Net investment

Net investment = Present value of (MLP + unguaranteed residual value) at the implicit rate

Equals gross investment less unearned finance income. At inception it normally equals the fair value of the asset.

Unearned finance income

Unearned finance income = Gross investment − Net investment

Total finance income the lessor will earn over the lease term.

Interest rate implicit in the lease

PV of (MLP + unguaranteed residual value) at implicit rate = Fair value of asset

The rate that makes the present value of what the lessor will receive equal to the asset's fair value.

Finance income for a period

Finance income = Opening net investment × Implicit rate

Gives a constant periodic rate of return on net investment outstanding.

Closing net investment

Closing net investment = Opening net investment + Finance income − Rent received

For rent paid at year end. If rent is paid in advance, deduct the rent first and then compute income on the balance.

Straight-line annual lease expense or income

Annual amount = Total lease rentals over the lease term ÷ Number of years in the lease term

Use this when rentals are uneven, unless another systematic basis better reflects the time pattern of benefit. Include rent-free periods in the lease term.

Difference between straight-line charge and cash

Difference = Straight-line amount − Cash rental for the year

For the lessee, positive = accrued liability (outstanding lease rent); negative = prepayment. For the lessor, positive (income > cash received) = accrued income receivable; negative = deferred or advance income.

Lessor's annual depreciation on leased asset

Depreciation as per the lessor's normal policy for similar owned assets (e.g. (Cost − Residual value) ÷ Useful life)

Depreciation is based on the asset's useful life, not on the lease term.

Initial direct costs, lessor (operating lease)

Expense immediately, or allocate over the lease term against lease income

Pick one method and apply it consistently. Do not add these costs to the asset's cost.

Lessor's net income from the lease

Net income = Lease income − Depreciation − Initial direct costs charged (and other operating costs)

Use this when the question asks for the lessor's profit for a year.

Finance leaseback: profit or loss

Deferred amount = Sale price − Carrying amount (an excess if positive, a deficiency if negative); amortise over lease term in proportion to depreciation of the leased asset

Nothing goes to profit and loss at the time of sale. The deferral covers both an excess and a deficiency of sale proceeds over carrying amount.

Operating leaseback: sale price = fair value

Profit or loss = Sale price − Carrying amount, recognised immediately

Applies when it is clear the deal is at fair value. If fair value is below carrying amount, the write-down rule (last row) applies. The loss is then carrying amount − fair value, which equals carrying amount − sale price here, so the figure is unchanged.

Operating leaseback: sale price > fair value

Immediate profit = Fair value − Carrying amount; Deferred = Sale price − Fair value

Use this when fair value is not below carrying amount. Amortise the deferred excess over the period the asset is expected to be used. If fair value is below carrying amount, use the last row instead.

Operating leaseback: sale price < fair value

If fair value ≥ Carrying amount: Profit or loss = Sale price − Carrying amount, recognised immediately. If fair value < Carrying amount: Loss = (Carrying amount − Fair value) + (Fair value − Sale price) = Carrying amount − Sale price

Exception: a loss compensated by below-market future rentals is deferred and amortised in proportion to lease payments over the expected period of use. When fair value is below carrying amount, the write-down loss (carrying amount − fair value) is always immediate. Only the further shortfall (fair value − sale price) can be deferred under this exception.

Operating leaseback: fair value < carrying amount

Only if fair value at the time of sale < Carrying amount: Step 1: Immediate loss = Carrying amount − Fair value (carrying amount is written down to fair value). Step 2: if Sale price > Fair value, Deferred profit = Sale price − Fair value. If Sale price < Fair value, further shortfall = Fair value − Sale price (immediate unless compensated by below-market rentals). Check: Sale price − Carrying amount = (Sale price − Fair value) − (Carrying amount − Fair value) in every case

This rule applies only when fair value at the time of sale is less than the carrying amount. The write-down loss and the sale price comparison are separate components that add up to the total (sale price − carrying amount). Example: carrying amount ₹50,00,000 and fair value ₹40,00,000. If sale price is ₹45,00,000, the immediate loss is ₹10,00,000 and the deferred profit is ₹5,00,000, which nets to a ₹5,00,000 loss (45,00,000 − 50,00,000). If sale price is ₹35,00,000, the loss is ₹10,00,000 plus ₹5,00,000, which is ₹15,00,000 (50,00,000 − 35,00,000). If fair value is not below carrying amount, there is no write-down.

Scope exclusions

AS 19 does not apply to: (1) leases to explore for or use natural resources; (2) licensing agreements for films, video recordings, plays, manuscripts, patents, copyrights; (3) lease agreements to use lands

Learn as three items. Leases of machinery, buildings, vehicles and equipment remain inside the standard. Only lease agreements to use lands are excluded under the land item. In a combined land-and-building lease, only the land element is outside AS 19.

Lessee, finance lease: key disclosures

Net carrying amount by asset class + reconciliation of total minimum lease payments (MLP) to present value + MLP and PV for three time bands + contingent rents expensed + future minimum sublease receipts + general description

Time bands: not later than one year; later than one year and not later than five years; later than five years.

Lessor, finance lease: key disclosures

Reconciliation of gross investment to PV of MLP receivable + gross investment and PV for three time bands + unearned finance income + unguaranteed residual values + accumulated provision for uncollectible MLP + contingent rents recognised + general description

Gross investment = MLP receivable + unguaranteed residual value.

Lessee, operating lease: key disclosures

Future MLP under non-cancellable leases (three time bands) + future minimum sublease payments expected + lease payments recognised in the year (MLP and contingent rent shown separately) + general description

Only non-cancellable leases go into the future-payments table.

Lessor, operating lease: key disclosures

For each asset class: gross carrying amount, accumulated depreciation and depreciation recognised for the period + future MLP under non-cancellable leases (three time bands) + contingent rents recognised as income + general description

The lessor keeps the asset in its own books, so asset-level details are needed. The lessor depreciates the leased asset consistently with its normal depreciation policy for similar assets, as per AS 6. AS 28 applies to decide whether the asset is impaired. Do not present impairment as an AS 19 disclosure item.

General description of leasing arrangements

Basis of contingent rent + renewal or purchase options and escalation clauses + restrictions (on dividends, additional debt, further leasing)

This appears in all four disclosure sets.

Quick revision

• A lease is finance if substantially all risks and rewards of ownership pass to the lessee; otherwise it is operating.
• Classification depends on the substance of the deal, not its legal form.
• Lessee in a finance lease records the asset and liability at the lower of fair value and present value of minimum lease payments.
• Each finance lease rental is split into finance charge and reduction of the outstanding liability.
• Finance charge is calculated on the opening outstanding balance using the interest rate implicit in the lease. The lessee's incremental borrowing rate is used only if the implicit rate is not practicable to determine.
• Lessee depreciates a finance-leased asset using the same policy it applies to owned depreciable assets, as per AS 10 (property, plant and equipment) and Schedule II. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the depreciable amount is depreciated over the shorter of the lease term and the asset's useful life.
• Lessor in a finance lease shows a receivable at the net investment, and recognises finance income on a constant periodic return basis.
• Operating lease rentals are generally recognised in profit and loss on a straight-line basis over the lease term.
• In an operating lease, the lessor keeps the asset in its books and depreciates it.
• If a sale and leaseback results in a finance lease, any excess of sales proceeds over the carrying amount is not immediately recognised as income but is deferred and amortised over the lease term.
• In a sale and leaseback with an operating lease, treat each case separately: - (a) Sale price equals fair value: recognise the profit or loss immediately. - (b) Sale price is below fair value: recognise the profit or loss immediately, except that a loss compensated by future rentals at below-market price is deferred and amortised in proportion to the rentals over the period the asset is expected to be used. - (c) Sale price is above fair value: defer the excess over fair value and amortise it over the period the asset is expected to be used. - (d) Fair value at the time of sale is less than the carrying amount: recognise immediately a loss equal to carrying amount minus fair value. Deal with any further difference between the sale price and fair value as in (b) or (c).
• Always attach working notes for present value, the schedule and the depreciation.

Common mistakes

• Classifying a lease by its name, such as treating a lease called 'rental agreement' as operating without testing it. Fix: Always run the tests. AS 19 classifies by transfer of risks and rewards, not by the title of the contract.
• Including contingent rent, maintenance charges or reimbursed taxes in MLP. Fix: MLP excludes contingent rent, costs for services and taxes reimbursed to the lessor. Strike them out first.
• Recording the asset at fair value even when the PV of MLP is lower. Fix: Always compute both figures and pick the lower. State the comparison in your answer.
• Including unguaranteed residual value in the lessee's MLP. Fix: For the lessee, include only residual value guaranteed by the lessee or a party related to it, limited to the amount guaranteed. Add a bargain purchase option price only where exercise is reasonably certain.
• Leaving out unguaranteed residual value from gross investment. Fix: Gross investment = MLP + unguaranteed residual value. Guaranteed residual is already in MLP, so do not add it twice.
• Treating the whole unearned finance income as income in year 1. Fix: Record the receivable at net investment. Credit income each year as opening net investment × implicit rate.
• Charging the cash rental paid in the year as the expense. Fix: When rentals are uneven, compute total ÷ years and charge that amount each year. Cash only decides the prepaid or accrued figure.
• Leaving out a rent-free period when counting years. Fix: The rent-free period is part of the lease term. Include it in the denominator.
• Recognising the full profit or loss immediately in a finance leaseback. Fix: For a finance leaseback, always defer the excess or deficiency of sale proceeds over carrying amount and amortise it over the lease term, in proportion to depreciation of the leased asset.
• Ignoring fair value in an operating leaseback and using sale price minus carrying amount for all profit. Fix: In an operating leaseback, split the gain at fair value. The part up to fair value is immediate. Any excess of sale price over fair value is deferred.

Exam tips

• In MCQs, the quickest filter is 'what is in and what is out of MLP'. Cross out contingent rent, services and reimbursed taxes before adding anything.
• When a question gives a PV factor, compute PV of MLP and compare it with fair value. Then also check the lease term against the economic life, because the examiner often sets two tests that agree.
• Write the answer as test, fact, conclusion for each test. This format earns step marks even if one figure goes wrong.
• Check the standpoint in the question. If it says 'in the books of lessee' or 'lessor', adjust the guarantee element of MLP to match.
• Learn the definitions of lease term, inception, non-cancellable lease and fair value in AS 19's own words. Short theory questions ask for them directly.
• Always state which is lower: fair value or PV of MLP. Examiners give a separate mark for this comparison.
• Draw the lease table even if only year 1 is asked. The table shows your method and protects your marks if arithmetic slips.
• Read the payment timing carefully. For payments in advance, the first payment is wholly principal at inception. Deduct it from the liability, and compute each finance charge on the balance remaining after the payment made at the start of that period.