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CMA Intermediate · Financial Accounting

Lease Accounting for CMA Intermediate

A lease lets the lessor convey the right to use an asset to the lessee for an agreed period in return for payments. You classify it at inception as finance or operating. For a finance lease, the lessee records an asset and a liability, then splits each payment into finance charge and liability reduction using the implicit rate.

What this chapter covers

This chapter is about one question: who should show the leased asset and the related obligation in their books? Under the standard text used here (AS 19), a lease is an agreement where the lessor conveys to the lessee, for a payment or series of payments, the right to use an asset for an agreed period. An operating lease is any lease that is not a finance lease. So everything starts with classification, made at the inception of the lease.

Once you classify, the chapter splits into clear routes. A finance lease needs a present value calculation, a discount rate (the interest rate implicit in the lease, or the lessee's incremental borrowing rate), and a payment schedule that separates finance charge from repayment of the liability. The lessor's side mirrors this through gross investment and unearned finance income. An operating lease is simpler, and sale and leaseback sits on top of it.

The chapter connects to the rest of Financial Accounting through present value, interest on a reducing balance, depreciation, and journal entries. Your ICMAI study material may also cover Ind AS 116, which changes the lessee model. The rules in this guide are based on the AS 19 text. Check your study material for exactly what your term's syllabus covers, and learn the Ind AS 116 basics as a separate comparison.

Lease Accounting is a numerical chapter where the method is fixed, so a prepared student can score full step marks. A typical question gives a fair value, annual payments and a residual value, and asks for the asset, the liability and a payment schedule. It also lends itself to MCQs on definitions, classification and treatment of profit in sale and leaseback. The calculations reuse skills you need elsewhere, so the effort pays back across the paper.

Lease Accounting: topics in the order to study them

  1. 1Introduction to Leases and Ind AS 116 BasicsStart with the definition of a lease, the lessor and lessee roles, and how the newer standard differs, so the terms are clear before any numbers.
  2. 2Classification of Leases: Finance vs OperatingEvery treatment depends on the type of lease, and classification is made at inception, so learn this before any entries.
  3. 3Lease Payments, Residual Value and Implicit RateThe asset, liability and income figures all come from these inputs, so master them before the full accounting.
  4. 4Accounting for Finance Leases in Books of LesseeThis is the most tested numerical route: initial recognition, finance charge and the liability schedule.
  5. 5Accounting for Finance Leases in Books of LessorIt reuses the same rate and cash flows from the other side, so it is easier once the lessee side is clear.
  6. 6Operating Leases and Sale and LeasebackStudy it last because sale and leaseback needs the lease types and fair value ideas from earlier topics.

How to prepare Lease Accounting

Treat this chapter as a short decision path followed by a repeatable calculation. Build the path first, then drill the numbers.

  1. Write the definition of a lease and the meaning of operating lease in your own words, then learn the classification test and the rule that classification is made at inception.
  2. Learn the key terms: residual value (estimated fair value of the asset at the end of the lease term), interest rate implicit in the lease, minimum lease payments, gross investment and unearned finance income.
  3. Practise the lessee's initial recognition: the amount is the fair value of the asset, but if fair value is higher than the present value of minimum lease payments from the lessee's standpoint, use that present value.
  4. Build the payment schedule on a fixed layout: opening liability, finance charge on the opening balance, payment, reduction in liability, closing liability. Solve at least five questions in this layout.
  5. Do the lessor side: gross investment, present value, unearned finance income, and the manufacturer or dealer lessor's sales revenue, cost of sale and selling profit.
  6. Finish with operating leases and sale and leaseback, and learn how the sale price against fair value decides whether profit is recognised now or deferred.
  7. Attempt 15 MCQs on definitions and classification, then one full written question under time, showing every working line.

Common mistakes in Lease Accounting

  • Classifying the lease from later events instead of at inception.

    Fix: Remember that classification is made at inception, and that changes in estimates or circumstances do not give a new classification.

  • Always recording the lessee's asset at fair value.

    Fix: Compare fair value with the present value of the lessee's minimum lease payments and record the lower figure. In the standard's example with a guaranteed residual of ₹5,000 only, the recorded amount is ₹2,27,805, not the fair value of ₹2,35,500.

  • Charging interest on the original amount every year.

    Fix: Charge the rate on the opening outstanding liability each year, so the finance charge falls as the liability falls.

  • Mixing up the lessee's and lessor's residual value figures.

    Fix: Label each cash flow as the lessee's or the lessor's view before discounting, and use the lessee's guaranteed figure only on the lessee side.

  • Treating all profit on sale and leaseback the same way.

    Fix: Check the leaseback type first, then compare sale price with fair value. At or below fair value, profit or loss is recognised immediately, except that a loss compensated by below-market future lease payments is deferred. Above fair value, defer and amortise the excess.

  • Leaving out the schedule in the written answer.

    Fix: Show the table with finance charge, payment, reduction and closing liability for each year. Small differences due to rate rounding are acceptable if you note them, as the standard does.

Last-day revision: Lease Accounting

  • A lease conveys the right to use an asset for an agreed period in return for payment or payments.
  • An operating lease is any lease other than a finance lease.
  • Classify the lease at inception.
  • Changes in estimates, such as of residual value, or in circumstances, such as lessee default, do not change the classification.
  • If the lessee and lessor agree to changed terms that would have given a different classification, treat it as a new agreement over its revised term.
  • Residual value is the estimated fair value of the asset at the end of the lease term.
  • Lessee recognises asset and liability at fair value, or at the present value of its minimum lease payments if that is lower.
  • Discount rate: the implicit rate if practicable to determine; otherwise the lessee's incremental borrowing rate.
  • Split each payment into finance charge and reduction of liability, giving a constant periodic rate on the remaining balance.
  • Finance charge = opening liability × rate. Example: ₹2,35,500 × 16% = ₹37,680.
  • Unearned finance income = gross investment less the present value of minimum lease payments and unguaranteed residual value at the implicit rate.
  • In sale and leaseback with an operating leaseback at fair value, recognise profit or loss immediately; if the sale price is above fair value, defer and amortise the excess.

Lease Accounting practice questions

Lease Accounting in other exams

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

Lease Accounting: frequently asked questions

What is the difference between a finance lease and an operating lease?

An operating lease is defined as any lease that is not a finance lease. The classification is made at the inception of the lease using the criteria in the standard. The lessee's and lessor's accounting depend on the result.

How does the lessee split a lease payment?

The payment is apportioned between the finance charge and the reduction of the outstanding liability. The finance charge is allocated so that it gives a constant periodic rate on the remaining balance. In practice, multiply the opening liability by the rate, then deduct that from the payment.

Which discount rate should I use for the lessee's present value?

Use the interest rate implicit in the lease if it is practicable to determine. If not, use the lessee's incremental borrowing rate. Read the question for which rate is given.

Do I need Ind AS 116 for this chapter?

The rules in this guide follow the AS 19 text. Ind AS 116 uses a different lessee model, so learn it as a separate comparison. Check your study material and the syllabus for your term to see how much is expected.