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CA Intermediate · Advanced Accounting · AS 19 Leases

Sundaram Textiles Ltd. takes a knitting machine on lease from Kaveri Leasing Ltd. for 3 years. The machine has an expected economic life of 10 years. The lease is non-cancellable. At the end of year 3 Sundaram has an option to buy the machine for ₹5,000, while the expected fair value at that date is ₹4,00,000. It is reasonably certain at inception that Sundaram will exercise the option. How should the lease be classified under AS 19?

The lease is a finance lease. The option to buy at ₹5,000 against an expected fair value of ₹4,00,000 is a bargain purchase option, and exercise is reasonably certain. Substantially all risks and rewards of ownership therefore pass to Sundaram, regardless of the short lease term or legal title.

  1. AFinance lease, because ownership is reasonably certain to pass to the lessee through a bargain purchase optionCorrect
  2. BOperating lease, because the lease term is much shorter than the machine's economic life
  3. COperating lease, because legal title does not pass to the lessee at inception
  4. DFinance lease only if the lease term covers at least 75% of the machine's economic life

Explanation

AS 19 treats a lease as a finance lease when it transfers substantially all risks and rewards of ownership. A purchase option at a price far below expected fair value, with reasonable certainty of exercise, is a standard indicator. The short lease term relative to the life does not override this, so the operating-lease options are wrong.

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