CFO Service

An Overview of Financial Lease Accounting in India

An Overview of Financial Lease Accounting in India

Lease contracts are those contracts where the property or the asset owners, allows the party to use the asset or the property in exchange of money or kind. The agreement is entered between the two parties, one is the Lessor, and the other is the Lessee, for the right to use an asset by the Lessee in return of some payment, at an agreed price. The lease accounting is subdivided into two parts-financial lease accounting and operating lease accounting.

The Indian Accounting Standard[1] is AS-19, which incorporates the accounting policies applicable to all types of leases, except for those mentioned in the list.

Main Ingredients of Accounting Standard (AS-19) are as follows:

  1. In the case of lease accounting, the lease transactions are capitalized on the Lessor’s books, the accounting is based on the financial or operating leases.
  2. In case of the financial lease accounting, the Lessor will not capitalize or depreciate the assets on his books; the Lessor will record the receivable, at the outstanding principal value. The assesse is going to record the asset at the fixed value asset and depreciate the same as per the standard depreciation policies of the Lessee. The Lessee will make a record, as a liability the present value of the lease rentals, as payable, other words, the principal inherent in future lease rentals.
  3. In case of the operating lease, the Lessor will account the asset as his asset, and it will depreciate the same as per the standard depreciation policy of the Lessor. The rentals are recognized as the Lessor’s income and expense by the Lessee, in case of structured rentals. The asset/liability will be off the books of the Lessee.
  4. In case of sale and leaseback transactions, if it results into a financial lease, the financial lease accounting shall be done; no profit on sale shall be booked by the seller-lessee, who will treat the sale proceeds as a liability.
  5. If a sale and leaseback transactions result into the operating lease, no profit or loss on the sale, considering only, the sale price of the asset, depending on the fair value of the asset.
READ  Payroll Services in India: Virtual CFO Services

Exceptions to Lease Agreements:

There cannot be lease agreements for the following;

  1. there cannot be lease agreement for exploring or using the natural resources,

Examples: oil, gas, timber, metals or other minerals rights.

  1. There cannot be a licensing agreement for the following

a. Motion pictures films
b. Video recordings
c. Plays
d. Manuscripts
e. Patents
f. Copyrights

  1. There cannot be a lease agreement for the land.

Understanding the concept of Financial Lease Accounting

After following the concept of the Mc Gregor, in which there is no classification can be done for the lease accounting, to follow the smart approach of worldwide accounting. The lease accounting is unaffected by the principle into financial lease accounting operating lease accounting.

The other accounting practice followed by the accountants is to do unequal sheet solutions; to their clients, which is called as the synthetic lease, where the Lessor does a financial lease accounting to a Special Purpose Vehicle-SPV, which in turn provides the operating to the Lessee.

Examples of Financial Leases, which are, as follows:

Types of Financial Leases - Under Financial Lease Accounting
  1. Transfer of asset

It is a lease in which the assets are transferred to Lessee at the end of the lease term

  1. Option to purchase by the Lessee

It means where the lease term is which the Lessee has the option to purchase the assets from the Lessor, at the price which is lower than the fair price, on the date when the option becomes exercisable.

  1. Covers the economic life of the asset
READ  10 Benefits of Hiring Virtual CFO Services

The lease terms become vital as they cover the economic life of the asset even if it is not transferred

  1. Meaning of Lease Term

The meaning of lease terms is that where, the lease term, in which the current value of or lease payments, is equal to or substantially covers the fair value of the leased asset.

  1. Specific Leased Asset

Ultimately, whatever is leased, that is, the leased asset has to be of specialized nature.

Accounting Treatment – cases of Lessor or Lessee- Financial Lease Accounting

Case of Lessee for Financial Lease Accounting

  1. At the fair value of the asset

The Lessee will recognize the lease as assets or liability at an equal amount to the fair value of the assets.

  1. Reduction of the outstanding liability

The apportionment of the lease payments into the finance charges, and reducing the outstanding liability

  1. Allocation of finance charges

The important part is to allocate the finance charges, to the periods during lease terms

  1. Depreciation

Pass the journal entries for the depreciation

Case of Lessor for the Financial Lease Accounting

  1. Assets at the net investment value

The Lessor is to record the assets in the books of accounts, at the amount to equal to net investment value.

  1. Periodic Rate of Return

There has to be a recording of the finance income based on the pattern reflecting the constant rate of return.

  1. Computing Gross Investment in Lease

The estimated unguaranteed residual value should be used in computing the lessor gross investment value.

  1. Revise the income allocation
READ  Why Outsourcing CFO Might Be Best for Your Business Growth

This has to be done in case where the estimated unguaranteed residual value has been reduced, check the income allocation over the remaining lease terms.

  1. Initial Direct cost

The initial direct cost associated with the lease to be recognized immediately in the profit or loss account or it can be spread over the lease term.

What are the Tax Benefits in the financial lease accounting?

  • The CBDT clarified in the notification that the change of accounting rules would not affect on the bearing of tax treatment.
  • The Lessor in the lease will claim the tax benefits without reflecting the asset as the fixed asset on the balance sheet.
  • This means that Lessor will be subjecting his gross rentals as income.
  • To the profits reported in the profit and loss account (P&L A/c), the principal portion of lease rentals shall not be recognized as income, which will be only added for tax purposes and depreciation will be allowed.


The financial lease accounting can be described as where the Lessee has designated a lease as a finance lease; it should recognize, that, – there is an ongoing amortization of the right of use asset; that there is a continuing amortization of the interest on the lease liability; that variable lease payments that are not included in the lease liability; that, there is no impairment of the right of use of an asset. These incidents make the lease as a financial lease accounting.

Read our article:Impact of Covid-19 on Financial Reporting

Trending Posted