This document defines a lease and the key parties involved - the lessor and lessee. It explains that a lease conveys the right to use an asset for a period of time in exchange for periodic payments. There are two main types of leases - operating leases and finance (or capital) leases. Finance leases transfer substantially all the risks and rewards of ownership to the lessee. For a finance lease, the lessee records the leased asset and a liability on its balance sheet. The criteria for classifying a lease as a finance lease include transfers of ownership, bargain purchase options, minimum lease payments equal to 90% or more of the asset's value, and lease terms that cover 75% or more of the

1. ACCOUNTING FOR LEASES
k.Mahamad rafi

2. Definition
• A lease is an agreement whereby the lessor
conveys to the lessee in return for a payment
or series of payments the right to use an asset
for an agreed period of time.

3. Definition
• A lease is an agreement between a lessor and
a lessee that conveys to the lessee the right to
use specific property, real or personal, owned
by the lessor, for a stated period of time. In
return for this right, the lessee agrees to make
periodic cash payments to the lessor.

4. Contd..
A lease is a contractual agreement:
- lessor (Owner of Property) conveys the right
to use property to
- lessee (User/Renter) in return for periodic
cash payments
- For stated period of time

5. Advantages of lease
1. No down payment.
2. Avoid risks of ownership.
3. Flexibility.
4. Protection against obsolescence
5. use of an asset without showing the
resources/sources.. Off-balance-sheet
financing

6. leases
Lessee
(group 1)
Capital
lease
Transfer of
ownership
Operating
lease
Rental
agreements
Lessor
(group 2)
Capital
lease
Direct
financing
Sales type
Operating
lease

8. Determine the criteria
• 1. Ownership transfer
• 2. Bargain purchase option
• 3. PV of MLP (minimum lease payment) is
equal to 90% of more
• 4. Lease term 75% or more of estimated
economic life

9. Types
• A finance lease is a lease that transfers
substantially all the risks and rewards incident
to ownership of an asset.
• An operating lease is a lease other than a
finance lease.
• Sale type lease the fair value of the property
at the inception of the lease is likely to be its
normal selling price

10. Capitalized amount of lease
• The Lessee records the lease an asset/liability:
LESSER OF:
1. FAIR VALUE of the asset at the inception of
lease or
2. PV of MLP (Present Value of Minimum
Lease Payments)

11. • In a capital lease transaction, the lessee records an
asset and a liability.
– The asset is depreciated by the lessee over the economic
life of the asset.
– The effective interest method is used to allocate the
rental payments between principal and interest.
– Depreciation of the asset and discharge of the lease
obligation are independent accounting procedures.

12. Finance Lease Valuation
• Lessee recognizes asset and liability arising
out of finance lease transaction applying
implicit interest rate / incremental borrowing
cost as discount factor
• Obligation under lease is simply finance lease
payables.

13. CERTAIN Terms
• Fair value is the amount for which an asset could
be exchanged or a liability settled between
knowledgeable, willing parties in an arm’s length
transaction.
• Economic life is either:
• (a) the period over which an asset is expected
to be economically usable by one or more users;
or
• (b) the number of production or similar units
expected to be obtained from the asset by one
or more users.

14. • Useful life of a leased asset is either:
• (a) the period over which the leased asset is
expected to be used by the lessee; or
• (b) the number of production or similar units
expected to be obtained from the use of the
asset by the lessee.
• Residual value of a leased asset is the
estimated fair value of the asset at the end of
the lease term.

15. Bargain purchase options (BPO)
• Another way a lease is equivalent to a
purchase is if the lessee can purchase the
asset for a bargain price at the end of the
lease.

16. • Inception of lease : Earlier of the date of the lease
agreement and the date of a commitment by the parties to
the principal provisions of the lease.
• Non-cancellable lease :Conditional cancellation -
(i) upon the occurrence of some remote contingency; or
(ii) with the permission of the lessor; or
(iii) if the lessee enters into a new lease for the same or an
equivalent asset with the same lessor; or
(iv) upon payment by the lessee of an additional amount
such that, at inception, continuation of the lease is
reasonably certain.

17. Valuation problem
• Suppose , fair value of an asset under finance lease is Rs.
775000 and the lessee agrees to pay @ Rs. 200000 p.a . His
incremental borrowing cost is 10%. Implicit interest rate is
10.42% .
• Present value of discounted cash flow Rs.758157 > 750000 .
Then the lessee should recognised asset and liability at fair
value.
• What if the fair value is Rs. 750000. Then the lessee should
account for the obligation at a higher amount. But the
leasehold asset should be recognized at fair value. The lessee
should then recognised loss at the inception of the
transaction.

18. ANY QUERIES

19. Thank you