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Considering an operating lease?
Lease machinery, equipment and fit-outs from ₹25 lakh to ₹100 crore.
Check eligibilityWhat makes a lease a finance lease
Ind AS 116 and AS 19 judge a lease on its substance, not its label. They list indicators that point to a finance lease. These four are the most common.
1
Ownership passes: the lease transfers title in the asset to the lessee by the end of the term.
2
Bargain purchase: the lessee can buy the asset at a price so far below its expected value that buying is reasonably certain.
3
Term and value: the term covers the major part of the asset's economic life, or the present value of rentals is substantially all of its fair value.
4
Specialised asset: it is so specialised that only the lessee can use it without major changes.
These are indicators, not a checklist, and the standards set no fixed percentages. Other signs include the lessee bearing the lessor's losses on cancellation or gains and losses from changes in residual value.
When a lease is a finance lease
The contrast is with an operating lease, where the lessor keeps the main risks and rewards of owning the asset.
WHAT CHANGES
Finance lease
Operating lease
Who bears residual value risk
Lessee, in substance
Lessor
Lessee under AS 19
Asset and liability on balance sheet
Rentals expensed over the term
Lessee under Ind AS 116
Right-of-use asset and lease liability
Same, unless short-term or low-value
Usual end of term
Lessee owns or buys
Return, re-rent or buy
How it is accounted for
Under AS 19 a lessee records a finance lease as an asset and a liability, at the lower of fair value and the present value of minimum lease payments. Each rental is split into interest and repayment, and the asset is depreciated.
Lessees under Ind AS 116.
Lessees no longer classify leases. Almost all leases, finance or operating, bring a right-of-use asset and a lease liability onto the balance sheet.
Lessors.
Ind AS 116 still requires lessors to classify. Under a finance lease the lessor records a lease receivable in place of the asset.
Classification is a judgement and tax treatment can differ. Confirm with your auditor and tax adviser.
Where it shows up
Two leases for one hospital's imaging unit
ILLUSTRATIVE
A hospital company reporting under Indian GAAP leases two machines. The first, an MRI scanner with an economic life of about eight years, is leased for seven years with an option to buy it at the end for a nominal sum. The term covers most of its life and purchase is near certain, so it is a finance lease: the hospital records the scanner and a matching liability. The second, an ultrasound unit, is leased for three years with return at the end and any purchase at fair market value. The lessor keeps the residual risk, so it is an operating lease and the rentals are expensed.