Advanced Accounting · AS 19 Leases

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

Updated 4 October 2026 · Fact-checked

In a finance lease, the lessor treats the asset as a lease receivable, not as its own asset. You record it at net investment, which is gross investment discounted at the implicit rate. The gap between gross and net investment is unearned finance income, which you recognise over the lease term at a constant rate on the outstanding net investment.

Understand Accounting for Finance Leases in Books of Lessor

In a finance lease, almost all risks and rewards of owning the asset pass to the lessee. So the lessor has, in substance, made a loan. It stops showing the asset in its books and shows a lease receivable instead. This is substance over form.

The receivable is not just the rent you will collect. It is the net investment in the lease. Start with the gross investment: all minimum lease payments from the lessor's side, plus any unguaranteed residual value that will come back to the lessor. Discount the gross investment at the interest rate implicit in the lease and you get the net investment. At inception, net investment normally equals the fair value of the asset.

The difference between gross and net investment is unearned finance income. It is the lessor's total interest over the lease. It is not income on day one. You spread it over the lease term so that each period gives a constant periodic rate of return on the net investment still outstanding.

Each rental has two parts. One part is finance income (opening net investment × implicit rate). The rest repays the receivable. So the receivable falls each year, and the finance income falls with it.

Residual value needs care. A residual value guaranteed by the lessee (or by a party related to the lessee, or by a financially capable third party) is part of minimum lease payments for the lessor. An unguaranteed residual value is not a minimum lease payment, but it is still added to gross investment. The lessor reviews the estimated unguaranteed residual value regularly. If it has fallen, the income allocation is revised and the reduction is recognised immediately.

Initial direct costs (such as commission and legal fees to arrange the lease) are either recognised as an expense immediately or allocated against finance income over the lease term. Follow the method the question states.

Key rules to remember

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.

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

Use this order for any lessor-side finance lease problem. Do the working in a table, because step marks are given for each figure.

1Confirm the lease is a finance lease (substance transfers risks and rewards). Then decide that the lessor records a receivable, not an asset.
2List the minimum lease payments from the lessor's view: rentals plus guaranteed residual value. Check who gives the guarantee.
3Add unguaranteed residual value, if any. Gross investment = MLP + unguaranteed residual value.
4Find net investment: use the present value given in the question, or discount at the implicit rate. If only the fair value is given, net investment = fair value (treat cost as equal to fair value unless told otherwise).
5Compute unearned finance income = gross investment − net investment.
6Build a table: opening net investment, finance income at the implicit rate, rent received, closing net investment. The last year's income is the balancing figure, so total income equals unearned finance income.
7Pass the entries: at inception, debit lease receivable and credit the asset or bank. Each year, debit bank, credit lease receivable and credit finance income.
8Deal with initial direct costs and any fall in unguaranteed residual value as the question states, and show the check that the final closing balance equals the residual value.

Quickest way: Table-first method for lessor finance lease questions

When to use it: Use for both MCQs and written answers when you have limited time and the question gives the rent, the residual value and the implicit rate or present value.

Write gross investment first: total rent + guaranteed residual + unguaranteed residual. Many MCQs ask only this.
Write net investment next. If the fair value or present value is given, use it. Do not recompute it.
Subtract to get unearned finance income. Check it is positive and less than the total rent.
For MCQs, eliminate options that treat the asset as still owned by the lessor, or show unearned income as income in year 1.
In a written answer, make a four-column table and fill year 1 only for a one-year question. For a full table, make the last year's income the balancing figure.
Check that the closing balance after the last rent equals the residual value in the receivable (guaranteed plus unguaranteed). If not, you have an error.
State the journal entries in a short line each, with narration, because step marks are given for them.

Common mistakes in Accounting for Finance Leases in Books of Lessor

Leaving out unguaranteed residual value from gross investment.
Students remember that unguaranteed residual value is not a minimum lease payment and so drop it altogether.
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.
Students book the receivable at gross investment and credit the difference to the profit and loss account at once.
Fix: Record the receivable at net investment. Credit income each year as opening net investment × implicit rate.
Computing finance income on the gross investment or on the original cost every year.
Students apply a flat rate to a fixed figure, as in simple interest.
Fix: Apply the rate to the opening net investment of that year. Net investment falls after each rent.
Crediting the whole rent as income.
Students treat the lease like an operating lease.
Fix: Split each rent: finance income goes to the profit and loss account; the balance reduces the lease receivable.
Treating residual value guaranteed by the lessor itself or by nobody as guaranteed.
Students see the word residual and do not check who guarantees it.
Fix: A residual value counts as guaranteed for the lessor only if the lessee, a party related to the lessee, or a financially capable third party guarantees it. Otherwise treat it as unguaranteed.
Forgetting to check that the last closing balance equals the residual value.
Rounding of present value factors leaves a small difference, and students leave it unexplained.
Fix: Make the last year's income the balancing figure so that the table closes exactly.

Worked examples

Example 1

Lessor Ltd leases a machine to a lessee on a finance lease for 3 years. Rent is ₹4,00,000 payable at the end of each year. The lessee guarantees a residual value of ₹1,00,000 at the end of year 3. The fair value of the machine (equal to its cost) is ₹10,69,872 and the implicit rate is 10%. Calculate the gross investment, net investment, unearned finance income, and the finance income for each year.

Show the solution

Minimum lease payments = 3 × ₹4,00,000 + guaranteed residual ₹1,00,000 = ₹13,00,000.
Unguaranteed residual value = nil. So gross investment = ₹13,00,000.
Net investment at inception = fair value = ₹10,69,872. This is the present value at 10% of the rents (₹4,00,000 × 2.48685) and the guaranteed residual (₹1,00,000 × 0.751315), rounded to the nearest rupee.
Unearned finance income = ₹13,00,000 − ₹10,69,872 = ₹2,30,128.
Year 1: income = ₹10,69,872 × 10% = ₹1,06,987. Closing net investment = ₹10,69,872 + ₹1,06,987 − ₹4,00,000 = ₹7,76,859.
Year 2: income = ₹7,76,859 × 10% = ₹77,686. Closing = ₹7,76,859 + ₹77,686 − ₹4,00,000 = ₹4,54,545.
Year 3: income is the balancing figure = ₹2,30,128 − ₹1,06,987 − ₹77,686 = ₹45,455. Closing = ₹4,54,545 + ₹45,455 − ₹4,00,000 = ₹1,00,000, which equals the guaranteed residual value.

Answer: Gross investment ₹13,00,000; net investment ₹10,69,872; unearned finance income ₹2,30,128. Finance income: year 1 ₹1,06,987, year 2 ₹77,686, year 3 ₹45,455.

Example 2

A lessor leases equipment on a finance lease for 3 years. Rent is ₹3,00,000 at the end of each year. A financially capable third party guarantees a residual value of ₹40,000. The lessor estimates a further unguaranteed residual value of ₹20,000. Cost equals fair value of ₹7,91,135, and the implicit rate is 10%. Find the minimum lease payments, gross investment, unearned finance income, and give the entries for inception and year 1.

Show the solution

Minimum lease payments (lessor's view) = 3 × ₹3,00,000 + guaranteed residual ₹40,000 = ₹9,40,000.
Gross investment = ₹9,40,000 + unguaranteed residual ₹20,000 = ₹9,60,000.
Net investment = fair value = ₹7,91,135. This is the present value at 10% of the rents and the total residual of ₹60,000, rounded to the nearest rupee.
Unearned finance income = ₹9,60,000 − ₹7,91,135 = ₹1,68,865.
Inception entry: Lease receivable A/c Dr ₹7,91,135 to Equipment A/c ₹7,91,135 (cost equals fair value, so there is no profit on the transfer).
Year 1 finance income = ₹7,91,135 × 10% = ₹79,113 (rounded).
Year 1 entry: Bank A/c Dr ₹3,00,000 to Lease receivable A/c ₹2,20,887 and to Finance income A/c ₹79,113.
Closing net investment at end of year 1 = ₹7,91,135 − ₹2,20,887 = ₹5,70,248.

Answer: Minimum lease payments ₹9,40,000; gross investment ₹9,60,000; unearned finance income ₹1,68,865. Year 1 finance income is ₹79,113 and the lease receivable at the end of year 1 is ₹5,70,248.

Exam tips

Write the words gross investment, net investment and unearned finance income as headings. Examiners give marks for each.
Read who guarantees the residual value. A guarantee by the lessee or a capable third party goes into minimum lease payments. Anything else is unguaranteed.
In MCQs, check whether the question asks for gross investment or net investment. Many wrong options use the other figure.
Always show a table for finance income across years and close it by checking the final balance against the residual value.
If initial direct costs are given, follow the treatment stated in the question and say which treatment you have followed.

Practice questions from AS 19 Leases

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

What is the difference between gross investment and net investment in a lease?

Gross investment is the minimum lease payments from the lessor's view plus any unguaranteed residual value, undiscounted. Net investment is that gross investment discounted at the implicit rate. The difference is unearned finance income.

How is finance income recognised by the lessor?

The lessor recognises finance income so that it gives a constant periodic rate of return on the net investment outstanding. Each year, it is the opening net investment multiplied by the implicit rate. It falls over time as the receivable is repaid.

Does the lessor charge depreciation on an asset given on a finance lease?

No. The asset is shown as a lease receivable, not as the lessor's own asset. The lessee, not the lessor, depreciates the asset in a finance lease.

How do I treat guaranteed and unguaranteed residual value?

Guaranteed residual value (guaranteed by the lessee or a capable third party) is part of the minimum lease payments. Unguaranteed residual value is not, but it is added to get the gross investment. Both are in net investment after discounting.