AS 19 Lease Accounting (part 3)

The third and final part of lease Accounting is sale and leaseback.  

 

Sale and lease back--

In this arrangement the property owner agrees to sell the asset at an agreed valuation and lease it back from the buyer. The lessee or seller receives the cash immediately and makes periodic payment in the form of lease.

Accounting treatment for sale and leaseback transaction:

1)      Finance lease:

 In case sale and leaseback is done as finance lease, the excess or deficit of sales price from carrying amount is to be amortized over lease term in proportion to the depreciation.

2) Operating lease:

Accounting treatment for sale and leaseback when done as operating lease is typical and easy just we need to understand it technically. Here it is:

First we need to concentrate on one point -that is, whether 1) Fair value is greater than Selling price or 2) Fair value is lower than Selling price.

1)      If FV>SP then ignore Fair value and just we need to determine amount between WDV or carrying amount and selling price; and recognize profit or loss accordingly.

2)      If FV<SP then we have to think about three condition:

(i)                  FV is greater than WDV—In that case, first, amount between WDV and FV should be recognized immediately and it must be profit; and finally, amount between SP to FV should be amortized in proportion to lease term.

(ii)                FV is equal to WDV—In that case, first, and last, amount between FV to SP should be amortized in proportion to lease term.

(iii)               FV is less than WDV—In that case, first, amount between FV to WDV should be recognized immediately –it must be loss; and finally, amount between FV to SP should be amortized in proportion to lease term.

After this above explanation, one thing is sure that amount between FV TO SP must be amortized if FV is less than SP and It is always profit because if FV is more than SP than FV is ignored.

Accounting concepts never get cleared unless we do some practical –let’s do that too:

 

Examples:

Suppose, a machine was sold at Rs 12000 and lease it back from buyer as operating lease for three year. The fair value of that machine was Rs 9000 and WDV or carrying amount was in case 1) Rs 7000, 2) Rs 11000 and in 3) Rs 9000.

Answer: For case 1) Profit of Rs 2000 (9000-7000) should be recognize immediately, and profit of Rs 3000 (12000-9000) should be amortized in proportion to lease term 3 years that is Rs 1000 for current year.

For case 2) Loss of Rs 2000 should be recognized immediately, and profit of Rs 3000 (12000-9000) should be amortized over 3 year.

For case 3) Profit of Rs 3000 should be amortized over lease term that is, three year. For current year it would be 1000.

Now take another example,

Suppose, a machine was sold at Rs 12000 and lease it back from buyer as operating lease for three year. The fair value of that machine was Rs 15000 and WDV or carrying amount was in case 1) 7000, 2) 11000 and in 3) 14000.

Answer:

For case 1) Profit of Rs 5000 should be recognized immediately.

For case 2) Profit of Rs 1000 should be recognized immediately.

For case 3) Loss of Rs 2000 should be recognized immediately.

So finally, we have come to an end of one more concept of Accounting. Hope you all like it. If you have any queries regarding this concept, feel free to write in comment box below.