NAS 17 Leases

1. Introduction
The objective of this unit is to focus on the appropriate accounting policies and disclosure to
apply in relation to leases.

Lease is an agreement whereby the lessor conveys to the lessee in return for rent the rights to
use an asset for an agreed period of time.

The classification of leases is based on the extent to which risks and rewards incidental to
ownership of a leased asset lie with the lessor or the lessee. A lease is classified as a finance
lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is
classified as an operating lease if it does not transfer substantially all the risks and rewards
incidental to ownership. Accounting and disclosures depend on classification of lease. NAS 17
Leases guide accounting and disclosures about leases.
ICAN – Advanced Accounting – CAP II- CHAPTER I

Illustration
An entity holds a property that it owns to earn rentals and for capital appreciation. It enters into
an agreement whereby it conveys to an independent third party in return for payment of Rs
1,000 per year the right to use the building for ten years.

Solution:

The arrangement is a lease—it is an agreement whereby the lessor (the entity) conveys to the
lessee (the independent third party) in return for payment or a series of payments (payment of
Rs. 1,000 per year) the right to use an asset (the building) for an agreed period of time (ten
years).

2. Classification of Lease
Lease transactions are classified into two types: finance lease and operating lease. Lease
classification is based on the extent to which risks and rewards incidental to the ownership of a
leased asset lie with the lessor or with the lessee. Finance lease is defined as lease that transfers
substantially all risks and rewards to the lessee. Title may or may not be transferred. An
operating lease is other than finance lease. Lease classification is carried out at the inception of
the lease.

The following situations individually or in combination would normally lead to a lease

being classified as a finance lease:
a. the lease transfers ownership of the asset to the lessee by the end of the lease term;
b. the lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable for it
to be reasonably certain, at the inception of the lease, that the option will be exercised;
c. the lease term is for the major part of the economic life if the asset even if title is
not
transferred;
d. at the inception of the lease the present value of the minimum lease payments amounts
to at least substantially all of the fair value of the leased assets; and
e. the leased assets are of such a specialized nature that only the lessee can use them
without major modifications.

The following situations individually or in combination could also lead to a lease being
classified as a finance lease:
a. if the lessee can cancel the lease, the lessor’s losses associated with the cancellation
are borne by the lessee.
b. gains or losses from the fluctuation in the fair value of the residual accrue to the lessee
(for example in the form of a rent rebate equaling most of the sales proceeds at the end
of the lease); and
c. the lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
ICAN – Advanced Accounting – CAP II- CHAPTER I

Illustration

A Ltd has taken a new lease comprising a factory building and surrounding land. The fair value
of the building is Rs.5,000,000 and the fair value of land is Rs.3,000,000. The lease term period
is 20 years, which is the expected life of the factory, with annual payments in arrears of
Rs.500,000. ALtd’s cost of capital is 8%. The annuity factor for Rs.1 receivable every year for
20 years is 9.818.

Solution

The lease payment should be split into payment for building and land in the ratio of fair
value
i.e. in the ratio of 5: 3. Rs.312,500 (500,000 x 5/8) will be treated as payment for building and
Rs.187,500 (500,000 x 3/8) will be treated as payment for land.

The payment for building will be treated as a finance lease because it is for the expected useful
life of the building.

The present value of the minimum lease payment for the land amounts to Rs.1,840,875
(187,500 x 9.818), this is not substantially the fair value of the land, so the lease of the land will
be treated as an operating lease.

3. The following terms should be known to for the understating of

accounting for leases:

a. Gross investment in the lease

Gross investment in the lease is the aggregate of:
i. the minimum lease payments receivable by the lessor under a finance lease; and
ii. any unguaranteed residual value accruing to the lessor.
b. Lease Term
The lease term is non-cancellable period for which the lessee has contracted to lease the
asset together with any further terms for which the lessee has the option to continue to
lease the asset, with or without further payment, when at the inception of the lease it is
reasonably certain that the lessee will exercise the option.

c. Contingent Rent
Contingent rent is that portion of the lease payment that is not fixed in amount but is
based on the future amount of a factor that changes other than with the passage of time
(e.g. percentage of future sales, amount of future use, future price indices, and future
market rate of interest)

d. Non-cancellable lease
A non-cancelable lease is a lease that is cancellable only:
i. upon the occurrence of some remote contingency;
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ii. with the permission of the lessor;

iii. if the lessee enters into a new lease for the same or a equivalent asset with the same
lessor; or
iv. upon payment by the lessee of such as additional amount that, at inception of the
lease, continuation of the lease is reasonable certain.

e. Unguaranteed residual value

Unguaranteed residual value is that portion of the residual value of the leased asset, the
realization of which by the lessor is not assured or is guaranteed solely by a party related
to the lessor.

f. Minimum Lease Payments

Minimum lease payments are payments over the lease term that the lessee is or required
to make, excluding contingent rent, costs for services and taxes to be paid by and
reimbursement to the lessor, together with:
(a) for a lessee, any amounts guaranteed by the lessee or by a party related to the lessee.
(b) for a lessor, any residual value guaranteed to the lessor by:
(i) the lessee;
(ii) a party related to the lessee; or
(iii) a third party unrelated to the lessor.

g. Net investment in the Lease

Net investment in the lease is the gross investment in the lease discounted at the interest
rate implicit in the lease.

4. Leases in the financial statements of lessees

a. Operating Leases
Lease payments under an operating lease shall be recognized as an expense on a straight-
line basis over the lease term unless another systematic basis is more representative of the
time pattern of the user’s benefit.

b. Finance Leases
At the commencement of the lease term, lessees shall recognize finance leases as assets
and liabilities in their balance sheets at amounts equal to the fair value of the leased
property or, if lower, the present value of the minimum lease payments, each determined
at the inception of the lease.
The discount rate to be used in calculating the present value of the minimum lease
payments is the interest rate implicit in the lease, if this is practicable to determine; if not,
the lessee’s incremental borrowing rate shall be used. Any initial direct costs of the lessee
are added to the amount recognized as an asset. Minimum lease payments shall be
apportioned between the finance charge and the reduction of the outstanding liability. The
finance charge shall be allocated to each period during the lease term so as to produce a
ICAN – Advanced Accounting – CAP II- CHAPTER I

constant periodic rate of interest on the remaining balance of the liability. Contingent
rents shall be charged as expenses in the periods in which they are incurred.
A finance lease gives rise to depreciation expense for depreciable assets as well as finance
expense for each accounting period. The depreciation policy for depreciable leased assets
shall be consistent with that for depreciable assets that are owned, and the depreciation
recognized shall be calculated in accordance with NAS 16 Property, Plant and Equipment
and NAS 38 Intangible Assets. If there is no reasonable certainty that the lessee will
obtain ownership by the end of the lease term, the asset shall be fully depreciated over the
shorter of the lease term and its useful life.

Example
On 1 January 2011 an entity entered, as lessee, into a five-year non-cancellable
lease of a machine that has an economic life of ten years, at the end of which it is
expected to have no value.

At the inception of the lease, the fair value (cash cost) of the machine is Rs.
100,000. On 31 December of each of the first four years of the lease term the lessee
is required to pay the lessor Rs.23,000. At the end of the lease term ownership of
the machine transfers to the lessee upon payment of the final lease payment of Rs.
23,539.

The interest rate implicit in the lease is 5 per cent per year which approximates
the lessee’s incremental borrowing rate.

On 1 January 2011 the lessee recognises the leased machine (as an item of
property, plant and equipment) and a finance lease liability measured at Rs.
100,000 (fair value of the leased machine at the inception of the lease, which is the
same as the present value of the minimum lease payment). The following journal
entry shall be passed to recognize the leased machine and obligation to pay:

Dr Property, plant and equipment (machine) Rs. 100,000

Cr Finance lease liability Rs. 100,000
To recognize the leased machine and the obligation to pay the lessor under the finance
lease.

5. Leases in the financial statements of lessor

a. Operating Leases
Lessor shall present assets subject to operating leases in their balance sheets according to
the nature of the asset. The depreciation policy for depreciable leased assets shall be
consistent with the lessor’s normal depreciation policy for similar assets, and depreciation
ICAN – Advanced Accounting – CAP II- CHAPTER I

shall be calculated in accordance with NAS 16 and NAS 38. Lease income from
operating leases shall be recognized in income on a straight-line basis over the lease term,
unless another systematic basis is more representative of the time pattern in which use
benefit derived from the leased asset is diminished.
b. Finance Leases
Lessor shall recognize assets held under a finance lease in their balance sheets and
present them as a receivable at an amount equal to the net investment in the lease. The
recognition of finance income shall be based on a pattern reflecting a constant periodic
rate of return on the lessor’s net investment in the finance lease.

Manufacturer or dealer lessor shall recognize selling profit or loss in the period, in
accordance with the policy followed by the entity for outright sales. If artificially low
rates of interest are quoted, selling profit shall be restricted to that which would apply if a
market rate of interest were charged. Costs incurred by manufacturer or dealer lessor in
connection with negotiating and arranging a lease shall be recognized as an expense when
the selling profit is recognized.
Illustration
Initial investments of the lessor is Rs.1,000,000 on account of purchase price of the plant and
machinery which was given on finance lease basis. As per the lease agreement, the lessor will
get annual lease payment of Rs.230,000. The lessee also guarantees residual value of
Rs.200,000 at the end of the lease term of 5 years which is also the economic life of the asset.
The lessor estimates unguaranteed residual value of Rs.50,000. The lessor incurred legal fees of
Rs.25,000 for lease documentation. He also apportioned Rs.30,000 on account of general
overheads for initiating and finalization of the lease arrangement.
How should the lessor account for the finance lease transactions?

Answer:
1. Gross Investment in Lease
Annual lease payment (Rs.230,000 ×5) Rs.1,150,000
Guaranteed residual value Rs.200,000
Minimum lease payments Rs.1,350,000
Unguaranteed residual value Rs.50,000
Rs.1,400,000

2. Fair value of leased out asset at the inception of the lease is its purchase price i.e.
Rs.1,000,000.
3. Direct costs to be included in the initial measurement of finance lease receivable
is
Rs.25,000 incurred on account of legal expenses. General overheads are not
included.
4. Calculation of implicit interest rate
(It is Internal Rate of Return of cash flows arising out of fair value of leased assets and
initial direct cost)
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Lessor’s purchase Annual Guaranteed

Year Unguaranteed Net cash
price and initial Lease residual
residual flow
direct costs Rental value
value
0 -1,025,000 -1,025,000
1 230,000 230,000
2 230,000 230,000
3 230,000 230,000
4 230,000 230,000
5 230,000 200,000 50,000 480,000
Implicit Interest Rate 10.07%
5. Net investment in lease
(Present value of gross investment at 10.07%)
Year Gross Investment Discount Factor Discounted Cash Flow
0 1
1 230,000 0.9085 208,955
2 230,000 0.8254 189,842
3 230,000 0.7498 172,454
4 230,000 0.6812 156,676
5 480,000 0.6189 297,073
Net Investment in Lease 1,025,000
Gross Investment in Lease 1,400,000
Unearned Finance Income 375,000

6. Income recognition and Balance Sheet value of Lease Receivables

Year Annual Lease Net Investment in Lease Finance Recovery of
Payment
Charge Investments
0 1,025,000
1 230,000 898,218 103,218 126,782
2 230,000 758,669 90,451 139,549
3 230,000 605,067 76,398 153,602
4 230,000 435,997 60,930 169,070
5 480,000 0 44,003 435,997
7. Accounting Entries in the books of Lessor
Year 0
Finance Lease Receivables Dr. 1,025,000
To Bank 1,025,000
(Purchase price of plant and machinery
and Initial Direct Cost)
Year
Bank1Dr. 230,000
To Finance Charge 103,218
To Finance Lease Receivables 126,782
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Year 2
Bank Dr. 230,000
To Finance Charge 90,451
To Finance Lease Receivables 139,549
And so on………
6. Sale and leaseback transactions
A sale and leaseback transaction involves the sale of an asset and the leasing back of the
same asset. The lease payment and the sale price are usually interdependent because they
are negotiated as a package. The accounting treatment of a sale and leaseback transaction
depends upon the type of lease involved.

Finance lease
If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds
over the carrying amount shall be deferred and amortized over the lease term.

Operating lease
If a sale and leaseback transaction results in an operating lease, and it is clear that the
transaction is established at fair value, any profit or loss shall be immediately recognized.
If the sale price is below fair value, any profit or loss shall be immediately recognized
except that, if the loss is compensated for by future lease payments below market price, it
shall be deferred and amortized in proportion to the lease payments over the period for
which the asset is expected to be used.
If the sale price is above fair value, the excess over fair value shall be deferred and
amortized over the period for which the asset is expected to be used.
Example
Sales value Rs.100,000, Fair Value Rs.100,000. Assume carrying amount (a) Rs.80,000, (b)
Rs.100,000 and (c) Rs.120,000. How should we recognize profit/ loss on sale (assuming case of
operating lease)?

Answer:
The sale is at fair value so we should immediately recognize the profit /loss on sale.
Carrying amount
Carrying amount Rs.80,000 Carrying amount Rs.120,000
Rs.100,000

Fair Value = Rs.100,000 Fair Value = Rs.100,000 Fair Value = Rs.100,000

Sale Value = Rs.100,000 Sale Value = Rs.100,000 Sale Value = Rs.100,000

Recognize the profit of No profit, no loss so no Recognize the Loss of
Rs.20,000 immediately. recognition of profit/loss. Rs.20,000 immediately.
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Example
Sale Value Rs.80,000, Fair Value Rs.100,000. Carrying amount Rs.70,000. How should we deal
with profit on sale (assuming case of operating lease)?

Answer:
If the sale price is below fair value, any profit or loss shall be immediately recognized.

We should recognize the profit of Rs.10,000 immediately.

Example
Sale Value Rs.100,000, Fair Value Rs.80,000. Assume carrying amount (a) Rs.70,000, (b)
Rs.80,000 , (c) Rs.90,000. How should we deal with the profit/loss on sale (assuming case of
operating lease) ?

Answer:
If the sale price is above fair value, the excess over fair value shall be deferred and amortized
over the period for which the asset is expected to be used.

Carrying
Carrying amount Rs.70,000 Carrying amount Rs.90,000
amount
Rs.80,000
Sale Value Rs.100,000 Sale Value Rs.100,000 Sale Value Rs.100,000

Fair Value Rs.80,000 Fair Value Rs.80,000 Fair Value Rs.80,000

Recognize the profit of Profit of Rs.20,000 should Recognize the loss

Rs.10,000 immediately (Fair be deferred and amortized of
value – carrying amount). (sale value – fair value). Rs.10,000
immediately (carrying amount
– fair value).
Profit of Rs.20,000 should be Profit of Rs.20,000 should be
deferred and amortized (sale deferred and amortized (sale
value – fair value). value – fair value).
Example
Sale Value Rs.80,000, Fair Value Rs.100,000. Assume carrying amount (a) Rs.90,000, (b)
Rs.100,000 and (c) Rs.110,000. How should we deal with loss on sale (assuming case of
operating lease) ?
ICAN – Advanced Accounting – CAP II- CHAPTER I

Answer:
Carrying amount Rs.90,000 Carrying amount Rs.100,000 Carrying amount Rs.110,000
Sale Value Rs.80,000 Sale Value Rs.80,000 Sale Value Rs.80,000
Fair Value Rs.100,000 Fair Value Rs.100,000 Fair Value Rs.100,000
Loss of Rs.10,000 (carrying Loss of Rs.20,000 (carrying Recognize the loss
amount – sale value) amount – sale value) of Rs.10,000
a. if compensated by future a. if compensated by future immediately
lease payments at below lease payments at below (carrying amount –
market price, the loss should market price, the loss should fair value).
be deferred and amortized. be deferred and amortized. Loss of Rs.20,000
(Fair Value – sale value)
b. otherwise recognize the b. otherwise recognize the a. if compensated by future
loss immediately. loss immediately. lease payments at below
market price, the loss should
be deferred and amortized.

b. otherwise recognize the

loss immediately.

4. Disclosures

A lessee shall make the following disclosures for finance leases:

(a) for each class of asset, the net carrying amount at the end of the reporting period.
(b) the total of future minimum lease payments at the end of the reporting period, for each
of the following periods:
(i) not later than one year;
(ii) later than one year and not later than five years; and
(iii) later than five years.
(c) a general description of the lessee’s significant leasing arrangements including, for
example, information about contingent rent, renewal or purchase options and
escalation clauses, subleases, and restrictions imposed by lease arrangements.
1. Write short notes on Minimum Rent and Short workings
(Inter Jun. 2001, Q 6a 4 Marks)
Answer:
Minimum Rent also known as Dead Rent is the minimum amount which the lessee has to pay
for each period even if the mine has not been worked at all or when the output for such period
is below a certain quantity provided for in the agreement.
 CAP II Paper 1: Advanced Accounting

Short workings arise when the minimum rent paid is in excess of that amount which would
have been payable on the basis of actual output.

Such short working may be recouped in the future years that means the actual royalty due
will be reduced to the extent of the unrecouped year/years which had shortcomings in
the past.

2. Basic criteria for classification of leases into Operating Lease and Finance Lease.
(June 2007,
Q 5c)
Answer:
Leases are classified based on the extent to which risks and rewards incident to ownership of
a leased asset lie with the Lessor or the Lessee.
Risks include the possibilities of losses from idle capacity or technological obsolescence and
of variations in return due to changing economic conditions.
Rewards may be represented by the expectation of profitable operation over the economic life
of the asset and of gain from appreciation in value or realization of residual value.

A lease is called a Finance Lease if it transfers substantially all the risks and rewards incident
to ownership. Title may or may not eventually be transferred. A lease is called an Operating
Lease if it does not transfer substantially all the risks and rewards incident to ownership.

3. Sale and lease back transaction

(CAP Dec. 2010 6a-2 Marks; CAP Dec. 2017 Q6c-3 Marks; CAP Jun. 2009 6e- 4 Marks)
Answer
As per NAS 17 on ‘Leases’, a sale and leaseback transaction involve the sale of an asset by
the vendor and the leasing back of same asset. The lease payments and the sale price are
usually interdependent, as they are negotiated as a package. The accounting treatment of a
sale and lease back transaction depends upon the type of lease involved.
If a sale and leaseback transaction results in a finance lease, any excess of sale proceeds
over the carrying amount shall not be immediately recognized as income by a seller-lessee.
Instead it shall be deferred and amortized over the lease term.
If sale and leaseback transaction results in an operating lease, and it is clear that the
transaction
is established at fair value, any profit or loss should be recognized immediately. If the sale
price is below fair value any profit or loss should be recognized immediately except that, if
the loss is compensated by future lease payments at below market price, it should be deferred
and amortized in proportion to the lease payments over the period for which the asset is
expected to be used. If the sale price is above fair value, the excess over fair value should be
deferred and amortized over the period for which the asset is expected to be used.
4. Lease (CAP Dec. 2013 6d-2.5 Marks)

Answer
 CAP II Paper 1: Advanced Accounting

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. A lease, based on the
features of the agreement can be classified as follows:
Finance Lease: A finance lease is a lease that transfers substantially all the risks and rewards
incidental to ownership of an asset. Title may or may not eventually be transferred. There are
certain conditions that are to be satisfied under NAS 17 for a lease to be classified as finance
lease.
Operating Lease: An operating lease is a lease other than a finance lease

5. A machine having expected useful life of 6 years is leased for 4 years. Both the cost and fair
value of the machinery are Rs. 17,00,000. The amount will be paid in 4 equal installments and
at the termination of lease, lessor will get back the machinery. The unguaranteed residual
value at the end of the 4th year is Rs. 1,70,000. The IRR of investment is 10%. The present
value of annuity factor of Rs. 1 due at the end of 4th year at 10% IRR is 3.169. The present
value of Rs. 1 due at the end of 4th year at 10% rate of interest is 0.683.
State with reason on the basis of your calculation, whether the lease constitutes finance lease or
not. (CAP Dec. 2018 Q5c-5
Marks)

Answer
As per NAS 17 on "Leases", one of the situations that individually or in combination would
normally lead to a lease being classified as a finance lease is that if at the inception of the
lease the present value of the minimum lease payment amounts to at least substantially all
of Determination
the fair value of
of the leased
nature asset.
of lease Rs.
Fair value of asset is Rs. 17,00,000 and unguaranteed residual value is Rs.1,70,000
Present value of residual value at the end of 4th =1,70,000*0.683 =1,16,110
year
Present value of lease payment recoverable = 17,00,000–1,16,110 =15,83,890
The percentage of present value of lease
payment to fair value of the asset is = (15,83,890/17,00,000) *100% =93.17%

Since the present value of minimum lease payment substantially cover the major portion of
fair value of leased assets and life of the asset, the lease transaction meets the definition of
finance lease as per NAS -17. Hence, it constitutes a finance lease.

6. Finance lease (Inter Jun. 2012 Q6d-5 Marks; CAP Jun. 2017 6e-3
Marks)
Answer:
A finance lease is lease that transfers substantially all the risks and rewards incidents to
ownership of an asset. Title may or may not eventually transferred.
Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form of the contract.1 Examples of situations that individually or
in combination would normally lead to a lease being classified as a finance lease are:
 CAP II Paper 1: Advanced Accounting

a) the lease transfers ownership of the asset to the lessee by the end of the lease term;
b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably
certain, at the inception of the lease, that the option will be exercised;
c) the lease term is for the major part of the economic life of the asset even if title is not
transferred;
d) at the inception of the lease the present value of the minimum lease payments amounts to
at least substantially all of the fair value of the leased asset; and
e) the leased assets are of such a specialized nature that only the lessee can use them
without
major modifications.
Indicators of situations that individually or in combination could also lead to a lease being
classified as a finance lease are:
f) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation
are
borne by the lessee;
b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee
(for example, in the form of a rent rebate equaling most of the sales proceeds at the end of
the lease); and
c) the lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.

7. FollowingYears
figures representLease
expected production
Amount (Rs) ofProduction
a machinery(MT)
taken on 5 years’ operating
lease: 1 15,000 13,000
2 35,000 21,000
3 50,000 34,000
4 47,000 32,500
5 44,500 30,000
191,500 130,500
Required:
Pass necessary journal entries in the books of lessee for initial two years.
(CAP Jun. 2010 Q4b- 5 Marks)
Answer
a) Lease rental to be recognized as expense in proportionate to units of production.
Here, Total lease rental for 5 years= Rs.191,500
Total Production for 5 years=130,500

Hence, Lease rental to be charged in 1st year=Rs. 13,000/130,500 X 191,500= Rs.19,077

Lease rental to be charged in 2nd year=Rs. 21,000/130,500 X 191,500=Rs.30,816

Journal Entries in the books of lessee for first and second year:
First Year
a) Lease Rent Dr 15,000
To Bank Cr. 15,000
 CAP II Paper 1: Advanced Accounting

(Being Lease rent for the first year of lease paid)

b) Lease Rent Dr 4,077

To Lease Rent Adjustment Ac Cr 4,077
(Being adjustment of lease rent for the year)

Second Year
a) Lease Rent Dr. 35,000
To Bank Cr. 35,000
(Being Payment of Lease rent for the year)

b) Lease Rent Adjustment Dr. 4,184

Lease Rent Expenses Dr. 30,816
To Lease Rent Cr. 35,000
(Being recognition of lease rent as expense for the year)

8. Initial recognition of finance lease in the financial statement of Lessee.

(CAP Jun. 2014 Q6d- 2.5 Marks)
Answer
At the commencement of the lease term, lessees shall recognize finance lease as assets and
liabilities at amount equal to the fair value of the lease property or, if lower, the present value
of the minimum lease payments, each determined at the inception of the lease. The discount
rate to be used in calculating the present value of the minimum lease payments is the interest
rate implicit in the lease, if practicable to determine; if not, the lessee’s incremental borrowing
rate shall be used. Any initial direct cost of the lessee is added to the amount as the asset.

9. M/s. Zipee Traders sold a car to a customer on installment sales basis.

The sales price of the car is Rs. 6,000,000.
The customer was required to pay following:
Shrawan Down Payment (At the
01, 2072 time of delivery) 3,000,000
Shrawan (includes Interest of
01, 2073 At the end of Year 1 1,860,000 Rs. 360,000)
Shrawan (includes Interest of
01, 2074 At the end of Year 2 1,680,000 Rs. 180,000)
Total Amount 6,540,000
M/s. Zipee Traders booked the entire Rs. 6,540,000 as sales on Shrawan 01, 2072. With
reference to the applicable NAS, explain whether the accounting treatment of M/s. Zipee
Traders is justifiable or not. (CAP Jun. 2016 Q5a- 5 Marks)

Answer
 CAP II Paper 1: Advanced Accounting

Under the provisions of NAS 17 Leases, Manufacturer or dealer lessors shall recognize
selling profit or loss in the period, in accordance with the policy followed by the entity
for outright sales. The lessor, under finance lease is required to recognize receivable at
an amount equal to Net investment in the lease and finance income should be
recognized shall be based on a pattern reflecting constant periodic return on the net
investment in the lease.

The recognition of entire amount of Rs. 6,540,000 as sales is not in line with the
aforementioned provisions. Zipee Traders should recognize sales to the extent of Rs.
6,000,000 at the time of the sales whereas the balance of 540,000 should be recognized
as finance income over the period of the lease.

10. Sagun Ltd. took a factory premises on lease on 01.04.2073 for Rs. 1, 00,000 per month.
The lease is operating lease. During Ashadh, 2074, Sagun Ltd. relocates its operation to
a new factory building. The lease of the old factory premises continues to live up to
31.12.2076. The lease cannot be cancelled and cannot be sub-let to another user. The
auditor insists that lease rent of balance 33 months up to 31.12.2076 should be provided
in the accounts for the year ending 31.03.2074. Sagun Ltd. seeks your advice.
(CAP Jun. 2017 Q5a-5 Marks)

Answer
In accordance with the provisions of NAS 37 ‘Provisions, Contingent Liabilities and
Contingent Assets’, if an enterprise has a contract that is onerous, the present obligation
under the contract should be recognized and measured as a provision. An onerous
contract is a contract in which the unavoidable cost of meeting the obligations under the
contract exceed the economic benefit expected to be received under it.
In the given case, the operating lease contract has become onerous as the economic benefit
of lease contract for next 33 months up to 31.12.2076 will be nil. However, the lessee,
Sagun Ltd., has to pay lease rent of Rs.3, 300,000 (i.e. Rs.100, 000 p.m. for next 33
months). Therefore, provision on account of Rs.3, 300,000 is to be provided in the
accounts for the year ending 31.03.2074.

Hence auditor’s contention to provide for the lease rent of balance 33 months up to
31.12.2076 in the accounts for the year ending 31.03.2074 is correct.