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CMA Intermediate · Financial Accounting · Lease Accounting

At inception, Ganga Tools Ltd. leased equipment classified as an operating lease. Two years later, the lessee defaulted on payments and the lessor revised its estimate of the equipment's residual value downward. How does AS 19 treat the classification?

The original operating lease classification stays. AS 19 makes classification at inception and says changes in estimates, such as residual value, or changes in circumstances, such as lessee default, do not create a new classification. Only agreed changes to lease terms can trigger a new agreement.

  1. AReclassify as a finance lease because of the default
  2. BReclassify as a finance lease because residual value fell
  3. CReclassify only if the lessor agrees in writing
  4. DRetain the original classification, as changes in estimates or circumstances do not give rise to a new classificationCorrect

Explanation

Classification is made at inception. Under AS 19, changes in estimates, such as residual value or economic life, and changes in circumstances, such as default by the lessee, do not give rise to a new classification. Reclassification applies only when the parties agree to change the lease provisions in a way that would have changed the classification.

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