Advanced Accounting · AS 19 Leases

Accounting for Finance Leases in Books of Lessee (AS 19)

Updated 4 October 2026 · Fact-checked

Under AS 19, a lessee records a finance lease asset and liability at the lower of the fair value and the present value of minimum lease payments. Each payment is split into finance charge (expense) and reduction of liability. The lessee also charges depreciation on the asset.

Understand Accounting for Finance Leases in Books of Lessee

A finance lease transfers substantially all risks and rewards of ownership to the lessee. So the lessee treats the deal like buying the asset with a loan, even though the legal title stays with the lessor.

At the start of the lease term, the lessee records the asset and the liability for the same amount. That amount is the lower of the fair value of the leased asset and the present value of minimum lease payments (MLP), both measured at the inception of the lease. The discount rate is the interest rate implicit in the lease. If it cannot be determined practically, use the lessee's incremental borrowing rate.

Each lease payment has two parts. One part is the finance charge, which goes to the Statement of Profit and Loss. The other part reduces the outstanding liability. The finance charge is allocated so that it gives a constant periodic rate of interest on the remaining liability. So interest each period = opening liability × rate.

The asset is depreciated like an owned asset. Depreciation is a separate charge from the finance charge. If there is reasonable certainty that the lessee will get ownership at the end, depreciate over the asset's useful life. Otherwise depreciate over the lease term or useful life, whichever is shorter. Initial direct costs of the lessee are added to the amount recognised as an asset.

Key rules to remember

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.

How to solve Accounting for Finance Leases in Books of Lessee questions

Follow the same order for any lessee finance lease problem. Do the recognition first, then the yearly split, then depreciation.

1Confirm the lease is a finance lease from the facts given, such as transfer of ownership, bargain option, lease term covering most of the life, or PV of MLP close to fair value.
2List the minimum lease payments for the lessee: rentals, plus residual value guaranteed by the lessee or a related party (up to the amount guaranteed), plus any bargain purchase price where exercise is reasonably certain. Leave out unguaranteed residual value.
3Find the present value of MLP using the given discount rate or PV factors.
4Take the lower of fair value and PV of MLP. Add initial direct costs to the asset only. Record Asset Dr to Lessor Cr.
5Check the payment timing, then prepare the right table. For payments at year end, use five columns: opening liability, finance charge (opening × rate), payment, principal repaid, closing liability. For payments in advance, use a separate layout: opening liability, less payment at start, balance, finance charge (balance × rate), closing liability (balance + finance charge).
6Compute depreciation on the recognised asset over the correct period, after deducting expected residual value.
7Post the yearly entries: finance charge Dr, lessor Dr, bank Cr; depreciation Dr, asset Cr. Then show the amounts in the Statement of Profit and Loss and balance sheet as asked.

Quickest way: Table-first method for lessee finance leases

When to use it: Use it when the question asks for the yearly finance charge, closing liability or journal entries, and you have limited time.

For MCQs, first compare fair value with PV of MLP and pick the lower. Many MCQs end there.
Check whether the payments are at year end or in advance. Pick the table layout to match. The two layouts are different, so do not mix them.
Payments at year end: write the five-column table. Finance charge = opening × rate, principal = payment − finance charge, and closing = opening + finance charge − payment.
Payments in advance: the payment at the start of the period is wholly principal, with no finance charge at that date. Write the columns as opening liability, less payment at start, balance, finance charge (balance × rate), and closing liability (balance + finance charge).
If the last closing balance is not zero (year-end table), or the liability is not cleared by the final advance payment, the PV or rounding is off. Recheck before moving on.
In written answers, show the formula, the figures and the final entry for each year. Step marks are given for the table, the entries and depreciation shown separately.

Common mistakes in Accounting for Finance Leases in Books of Lessee

Recording the asset at fair value even when the PV of MLP is lower.
Students remember that fair value is the cost of the asset and skip the comparison.
Fix: Always compute both figures and pick the lower. State the comparison in your answer.
Including unguaranteed residual value in the lessee's MLP.
The lessor's MLP includes it, and students mix up the two sides.
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.
Charging the whole lease rental to the Profit and Loss account.
Students apply operating lease treatment out of habit.
Fix: Split each payment. Only the finance charge and depreciation go to the Statement of Profit and Loss. The principal part reduces the liability.
Calculating the finance charge on the original liability every year.
Students treat it as simple interest.
Fix: Charge the rate on the opening outstanding balance for each period, which gives a constant periodic rate.
Adding initial direct costs to the lease liability.
Both asset and liability are expected to be equal.
Fix: Add initial direct costs only to the asset. The liability stays at the lower of fair value and PV of MLP.
Depreciating over the wrong period.
Students ignore whether ownership will pass to the lessee.
Fix: If ownership is reasonably certain to pass, use useful life. Otherwise use the shorter of lease term and useful life.

Worked examples

Example 1

A Ltd. leases a machine on 1 April 2026 under a finance lease. Fair value of the machine is ₹3,31,000. Lease rentals are ₹1,33,100 payable at the end of each year for 3 years. The interest rate implicit in the lease is 10%. Ownership passes to A Ltd. at the end of the lease. Useful life is 3 years, with no residual value. Show the lease table and the first year's charge to profit and loss. Ignore direct costs.

Show the solution

PV of MLP at 10% = 1,33,100 ÷ 1.1 + 1,33,100 ÷ 1.21 + 1,33,100 ÷ 1.331 = 1,21,000 + 1,10,000 + 1,00,000 = ₹3,31,000.
Fair value is ₹3,31,000 and PV of MLP is ₹3,31,000. The two figures are equal here only because the question's data was built that way, with no unguaranteed residual value. This need not hold in general, so always compute both figures. The asset and liability are recorded at ₹3,31,000.
Entry: Machine A/c Dr ₹3,31,000 to Lessor A/c ₹3,31,000.
Year 1: finance charge = 3,31,000 × 10% = ₹33,100. Payment ₹1,33,100. Principal = ₹1,00,000. Closing liability = ₹2,31,000.
Year 2: finance charge = 2,31,000 × 10% = ₹23,100. Principal = 1,33,100 − 23,100 = ₹1,10,000. Closing liability = ₹1,21,000.
Year 3: finance charge = 1,21,000 × 10% = ₹12,100. Principal = 1,33,100 − 12,100 = ₹1,21,000. Closing liability = ₹0. The table closes to zero.
Depreciation for year 1 = 3,31,000 ÷ 3 = ₹1,10,333 (rounded), as ownership passes and useful life is 3 years.
Year 1 charge to Profit and Loss = finance charge ₹33,100 + depreciation ₹1,10,333 = ₹1,43,433.

Answer: Asset and liability are recorded at ₹3,31,000 (fair value and PV of MLP are the same here). Year 1 finance charge is ₹33,100, closing liability is ₹2,31,000, depreciation is ₹1,10,333, and the total charge to Profit and Loss is ₹1,43,433.

Example 2

On 1 April 2026, B Ltd. takes a machine on finance lease. Fair value is ₹1,50,000. The lessee pays ₹60,000 at the end of each year for 3 years. The rate implicit in the lease is 12%. The PV of an annuity of ₹1 for 3 years at 12% is 2.402. Useful life is 5 years and ownership does not pass to B Ltd. Initial direct costs paid by B Ltd. are ₹4,000. Compute the recognised asset value, the year 1 finance charge, and the year 1 depreciation.

Show the solution

PV of MLP = 60,000 × 2.402 = ₹1,44,120.
Fair value is ₹1,50,000. The lower figure is ₹1,44,120, so the liability is ₹1,44,120.
Asset value = 1,44,120 + initial direct costs 4,000 = ₹1,48,120.
Year 1 finance charge = 1,44,120 × 12% = ₹17,294 (rounded).
Principal repaid in year 1 = 60,000 − 17,294 = ₹42,706. Closing liability = 1,44,120 − 42,706 = ₹1,01,414.
Ownership does not pass, so depreciate over the shorter of lease term (3 years) and useful life (5 years), which is 3 years.
Depreciation = 1,48,120 ÷ 3 = ₹49,373 (rounded), assuming no residual value.

Answer: Asset is recognised at ₹1,48,120 and the liability at ₹1,44,120. Year 1 finance charge is ₹17,294, closing liability is ₹1,01,414, and depreciation is ₹49,373.

Example 3

C Ltd. takes a machine on finance lease on 1 April 2026. Fair value is ₹3,50,000. Lease rentals are ₹1,21,000 payable in advance on 1 April each year for 3 years (1 April 2026, 2027 and 2028). The rate implicit in the lease is 10%. Show the liability at inception and the finance charge for each year. Ignore direct costs.

Show the solution

PV of MLP = 1,21,000 + 1,21,000 ÷ 1.1 + 1,21,000 ÷ 1.21 = 1,21,000 + 1,10,000 + 1,00,000 = ₹3,31,000.
Fair value is ₹3,50,000 and PV of MLP is ₹3,31,000. The lower figure is ₹3,31,000, so the asset and liability are recorded at ₹3,31,000.
1 April 2026: the first payment of ₹1,21,000 is made on the day the lease starts. No finance charge has accrued, so the whole payment is principal. Liability after the payment = 3,31,000 − 1,21,000 = ₹2,10,000.
Year 1 (2026-27): finance charge = 2,10,000 × 10% = ₹21,000. Liability before the next payment = 2,10,000 + 21,000 = ₹2,31,000.
1 April 2027: payment ₹1,21,000 is wholly principal on that date. Liability after the payment = 2,31,000 − 1,21,000 = ₹1,10,000.
Year 2 (2027-28): finance charge = 1,10,000 × 10% = ₹11,000. Liability before the next payment = 1,10,000 + 11,000 = ₹1,21,000.
1 April 2028: the last payment of ₹1,21,000 clears the liability to ₹0. So there is no finance charge for year 3.
Check: total payments 3,63,000 − liability recognised 3,31,000 = 32,000, which equals the finance charges 21,000 + 11,000.

Answer: Asset and liability are recorded at ₹3,31,000. The liability after the first payment is ₹2,10,000. Finance charge is ₹21,000 for year 1, ₹11,000 for year 2 and nil for year 3. Total finance charge is ₹32,000.

Exam tips

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.
Show depreciation and finance charge as two separate lines in the Statement of Profit and Loss working. Never merge them.
In MCQs, check whether the question includes a guaranteed residual value or a bargain option. It changes the MLP, and wrong options are often built on forgetting it.

Practice questions from AS 19 Leases

Accounting for Finance Leases in Books of Lessee in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Accounting for Finance Leases in Books of Lessee: frequently asked questions

At what value does the lessee record a finance lease under AS 19?

The lessee records the asset and liability at the lower of the fair value of the leased asset and the present value of minimum lease payments, both at the inception of the lease. Initial direct costs of the lessee are added to the asset.

Is the whole lease rental an expense for the lessee in a finance lease?

No. Each rental is split into a finance charge and a repayment of the liability. Only the finance charge is an expense, along with depreciation on the asset.

Which discount rate is used to find the present value of MLP?

Use the interest rate implicit in the lease. If it is not practicable to determine it, use the lessee's incremental borrowing rate.

Over what period is a leased asset depreciated?

If the lessee is reasonably certain to get ownership at the end of the lease, depreciate over the asset's useful life. If not, depreciate over the shorter of the lease term and the useful life.