Question 5 (a)

Finance lease: classification criteria (AS-19)

3 marks

Time to write
About 6 minutes
Topic
Leases and AS 19
Notes
Crux notes

Question

Question 5 (a) · 3 marks

State the situations under AS-19 that would normally lead to a lease being classified as a finance lease.

Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

6 minfor 3 marks

Read from the question

  • StateShort and exact: no long explanation.

Write it in this order

  1. 1 Definition: transfer of substantially all risks and rewards 1 mark 2 min
  2. 2 The classification situations ownership transfer, bargain option, major part of life, PV = fair value, specialised asset 2 marks 4 min

Easy marks

  • Step 1 opens with the meaning: a one-line definition, the quickest mark in it.

Try it first. About 6 minutes for 3 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

A finance lease is one that transfers substantially all the risks and rewards incident to ownership of the asset; title may or may not eventually pass. A lease is normally classified as a finance lease where one or more of the following apply:

Picture itFinance lease: classification criteria (AS-19)

1The press is signed over for nearly its whole life—oiling, repairs and all are the lessee's now.

Finance leaseA lease that transfers substantially all the risks and rewards incident to ownership of an asset

2The laptops come like a rental: used for the season, then carried back out the door.

Operating leaseLike a rental agreement

  1. The lease transfers ownership of the asset to the lessee by the end of the lease term.
  2. The lessee has an option to purchase the asset at a price expected to be well below fair value (a bargain purchase option), so that exercise is reasonably certain at inception.
  3. “The lease term is for the major part of the economic life of the asset, even if title is not transferred” (AS 19, para 8(c)).
  4. At inception, the present value of the minimum lease payments is substantially equal to the fair value of the leased asset.
  5. The asset is of a specialised nature such that only the lessee can use it without major modifications.

Whether or not title eventually passes to the lessee, a lease that hands over these risks and rewards is a finance lease; a lease that does not: typically for a period shorter than the asset's economic life: is an operating lease.

Where the 3 marks sit

#ComponentMarks
1Definition: transfer of substantially all risks and rewards1
2The classification situations (ownership transfer, bargain option, major part of life, PV = fair value, specialised asset)2
Total3
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