1.32 Query: Accounting for operating lease by manufacturers.
1. A company is engaged in the business of manufacturing and selling solid state electronic energy meters. It now intends to supply its products on operating lease basis. As per the querist, the company wishes to capitalise its equipments, to be so leased out, at 75% of the sales value.
2. The querist has stated that International Accounting Standard (IAS) 17 requires that all the costs and receipts relating to operating leases should be accounted for in the profit ad loss account. Also, as per the queist, in the case of operating lease, the title to the assets vests in the lessor and he is entitled to claim depreciation and other such benefits.
3. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) What entry should be passed for the capitalisation of the equipments manufactured and given on operating lease?
(b) Will it be acceptable to the auditors and Income-tax authorities if the assets are capitalised by crediting the capital reserve account?
Opinion February 3, 1994
1. The Committee notes paras 4 and 17 of the Guidance Note on Accounting for Leases, issued by the Institute of Chartered Accountants of India, which are reproduced below:
“4. A lease is classified as a finance lease if it is secures for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term. Such a lease is normally non-cancellable and the present value of minimum lease payments at the inception of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset.”
“17. A lease is classified as an operating lease if it does not secure for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term. Therefore, the asset should be treated by the lessor as a fixed asset and rentals receivable should be included in income over the lease term.”
2. Since, as per the above, the assets given an operating lease are to be treated as the fixed assets of the lessor, the Committee is of the view that the valuation of such assets should also be done, by applying the general principles of accounting applicable to the other fixed assets, as laid down in Accounting Standard (AS) 10, issued by the Institute of Chartered Accountants of India.
3. The Committee notes that Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, states that the cost of self-constructed assets should be determined by applying the same principles, as are applied to the other fixed assets. Para 10.1 of the said accounting standard reads as follows-
“10.1 In arriving at the gross book value of self-constructed fixed assets, the same principles apply as those described in paragraph 9.1 to 9.5. Included in the gross book value are costs of construction that relate directly to the specific assets and costs that are attributable to the construction activity in general and can be allocated to the specific assets. Any internal profits are eliminated in arriving at such costs.”
4. On the basis of the above, the Committee is of the following opinion in respect of the issues raised in para 3 of the query:
(a) The assets manufactured by the company which are given on operating lease should be capitalised at the cost determined as per 3 above. The historical cost of the meters so determined and transferred to fixed assets should be credited to the profit and loss account so that it is matched with the relevant costs of manufacturing such meters which would be appearing on the debit side of the profit and loss account.
(b) Capilisation of the self-manufactured assets by crediting the capital reserve account is not appropriate as discussed in (a) above. _________________________________ |