Valuation of Assets under Finance Lease, Intangible Assets and

Impairment of Assets

Lease 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.

Finance and Operating Lease Finance Lease: Lease that transfers

substantially all the risks and rewards incident to ownership of an asset.

Operating Lease: A Lease other than finance lease.

AS 19 – Lease - Scope Applicable for all leases other than

Lease agreements to explore for or use of natural resources, such as oil, gas, timber, metals and other mineral rights;

Licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights; and

Lease agreements to use lands

Accounting for Leases by the lessee A finance lease should be reflected in the

balance sheet of a lessee by recording an asset and a liability at amounts equal at the inception of the lease to the fair value of the leased asset net of grants and tax credits receivable by the lessor; if lower, at the present value of the minimum lease payments. The discount factor being the interest implicit in the lease, if it is practicable to determine, otherwise the lessee’s incremental borrowing rate.

The rentals should be apportioned between the finance charge and the reduction of the outstanding liability.

The finance charge should be allocated to the periods of the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period.

Accounting for Leases by the lessee

A finance lease gives rise to a depreciation charge for the asset as well as a finance charge for each accounting period.

The depreciation policy for leased assets should be consistent with that for depreciable assets which are owned and the depreciation charge should be calculated on the basis set out in AS-6. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the lease term or its useful life , whichever is shorter.

Accounting for Leases by the lessee

Operating Lease The charge to operating income

under an operating lease should be the rental expenses for the accounting period, recognized on a systematic basis that is representative of the time pattern of the user’s benefit.

Disclosures Amount of assets that are subject to finance

lease at each balance sheet date. Liabilities related to these leased assets should be shown separately from other liabilities, differentiating between the current and the long-term portions

Commitment for minimum lease payments with a term of more than one year should be disclosed in summary form giving the amounts and periods in which the payment would become due.

Renewal / purchase options and other contingencies arising from leases

Illustration - BHEL Assume that BHEL has entered into a

lease agreement for a equipment costing Rs.750 lakh. The lease is non-cancelable for a period of 5 yrs. The annual lease rentals payable amount to Rs 300/Rs 1000. The economic life of the equipment is expected to be 8 yrs. BHEL uses WDV and 30% to depreciate the equipment. The incremental borrowing rate is 16%.

Intangible Assets Non-monetary assets without physical

substance, held for use in the production or supply of goods or services, for rental to others or for administrative purposes. Can generate future earnings. Long term assets classified under Fixed assets. Eg. Brand names, trademarks, copyrights, customer lists, computer software, licenses, formulas, know-how, processes, patents, goodwill, franchises.

Intangible Assets The value of intangible asset arises from the

long-term rights, privileges or advantages it confers on the owner

Recorded at cost. Costs include all costs of acquisition and

expenditures necessary to make the intangible asset ready for its intended use (purchase price, legal fees, and other costs incurred in obtaining the asset)

Intangible assets acquired at no cost are not shown on the balance sheet, even though they may be of considerable value to the enterprise.

Amortization – AS-26 Amortization – write-off to expense of the

cost of an intangible asset over its useful life, usually the lower of its legal life and estimated commercial life.

AS-26 – the useful life of an intangible asset will not exceed 10 yrs from the date when it is available for use, unless the enterprise establish that it has a longer life.

IT Rules – 25%WDV for tax purposes for know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature.

Intangible Assets Patent Copyright Trademark, Brands Franchise, license Goodwill R&D costs Computer software costs Deferred charges – preoperating and start-up

costs, share and debenture issue expenses, company formation expenses, new product marketing costs, plant rearrangement and moving costs, items that have debit balances – other than n fixed assets as “Miscellaneous expenditure to the extent not written off”, revenue expenses carried forward “ DREs”.

Impairment of Assets Asset – a collection of expected

future economic benefits. If the value recoverable from future

use of an asset is less than its carrying amount, there is an impairment loss, measured as the difference between the two amounts.

AS-28 If the recoverable amount of an asset

is less than its carrying amount, the carrying amount of the asset should be reduced to its recoverable amount. That reduction is an impairment loss.

Recoverable amount is the higher of an asset’s net selling price and its ‘value in use’.

AS-28 Value in use – PV of estimated future cash

flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life and applying appropriate discount rate.

Impairment loss – P&L and balance sheet, depreciation.

Reversal Disclosures