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CMA Intermediate · Financial Accounting · Lease Accounting

Kaveri Logistics leased a vehicle from a finance company, and the lease was classified as a finance lease at inception. In the second year, Kaveri defaulted on some payments and the lessor also revised its estimate of the vehicle's residual value. How should the classification of the lease be treated?

The classification stays as it was. Under AS 19, changes in estimates, such as residual value, and changes in circumstances, such as lessee default, do not create a new classification. Only an agreed change of lease terms that would have changed the classification at inception does.

  1. AReclassified as an operating lease because of the default
  2. BReclassified because the residual value estimate has changed
  3. CThe classification does not change, as changes in estimates or circumstances such as default do not give rise to a new classificationCorrect
  4. DReclassified only in the lessor's books, not in the lessee's books

Explanation

AS 19 states that changes in estimates (such as residual value) or changes in circumstances (such as default by the lessee) do not give rise to a new classification of a lease for accounting purposes. Reclassification arises only when the parties agree to change the lease provisions in a way that would have produced a different classification at inception.

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