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Lease Rent Equalisation

Lease Rent Equalisation

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Published by MM_AKSI

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Published by: MM_AKSI on Dec 14, 2012
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10/31/2014

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Expert Advisory Committee
Search:Options: phrase case-sensitive
ICAI-
 ExpertAdvisoryCommittee
 Advanced Search
QueryNo.
6
Subject
:
Computationofleasetermandaccountingforscheduledrentincreasesincaseofanoperatinglease.
1
A. Facts of the Case
1. A company is in transport industry and provides radio taxi services across India. The company (hereinafter referred to as ‘the lessee’) has taken on1st September, 2007, a premises on lease. The term of the lease is 5 years and it is renewable at the end of the lease term. The querist has provided thefollowing clauses of the agreement (hereinafter referred to as the ‘first lease agreement’):“That the lease shall be for a period of 5 years, commencing from 1st September, 2007. On expiry of the lease period of 5 years, the lease can berenewed. After 12 months, 5% enhancement will be done every year.”“That notwithstanding that is stated above, this agreement is terminable by 3 months notice in writing by either side.”According to the querist, there is no non-cancellable period in the agreement as there is no lock-in-period.2. On 1st August, 2007, the company has taken another premises on lease. The querist has provided the following clauses of the agreement (hereinafterreferred to as the ‘second lease agreement’):Page 1 of 5Query No8/31/2012http://220.227.161.86/eac/eacfinal/vol29/6.html
 
“In consideration of the lease rental hereinafter reserved and all the covenants and conditions hereinafter contained to be observed and performedon the part of the lessee, the lessor does hereby agree to grant, demise by way of lease the demised premises to the lessee for a period of five years from1st August, 2007 to 31st July, 2012 with the
sole and absolute option
of lessee to extend the lease for a period of four years on the same terms andconditions, except rent, by execution of fresh lease agreement for such extended period of four years. After expiry of subsequent four years, i.e., on31st July, 2016, if extension is required a fresh lease deed shall be executed in writing and registered on mutually agreed rent, terms and conditions”.(Emphasis supplied by the querist.)“That the lease deed shall commence and come into operation with effect from 1st August, 2007.”“The rent shall be as follows:A. For the first three years of period commencing from 1st August, 2007 to 31st July, 2010, the rent shall be Rs. 5,15,000 per month (Rupees fivelakh fifteen thousand only).B. For the second three years commencing from 1st August, 2010 to 31st July, 2013, the rent shall be Rs. 6,18,000 per month (Rupees six lakheighteen thousand only).C. For the third three years, final period commencing from 1st August, 2013 to 31st July, 2016, the rent shall be Rs. 7,41,600 per month (Rupeesseven lakh fourty one thousand six hundred only).However, a fresh deed will be executed and registered after the expiry of 5 years period.”“The lessee shall be entitled to terminate the lease by giving three months advance notice to the lessor and upon expiry of such notice period, thelessee shall hand over physical vacant possession of the demised premises to the lessor. However, in case the lessee wants to vacate the demisedpremises before the expiry of four years from the date of signing of this lease deed, the lessee can do so by giving four months advance notice to thelessor. During the notice period rent will be paid by the lessee.”As per the querist, there is no non-cancellable period in the agreement as there is no lock-in-period. The querist has further clarified that the lessor,under the agreement, does not have a right to ask the company to vacate the premises.3. The querist has stated that there may be various kinds of lease agreements entered into by the company:(i) Lease agreement with no ‘non-cancellable period’.(ii) Lease agreement with non-cancellable period
together with
any further periods for which the lessee has the option to continue the lease(emphasis supplied by the querist).(iii) Lease agreement with cancellable period together with any further periods for which the lessee has the option to continue the lease.Page 2 of 5Query No8/31/2012http://220.227.161.86/eac/eacfinal/vol29/6.html
 
4. The auditors of the company have advised the company to consider all the periods, whether cancellable or non-cancellable lease term and equalisethe rent over the lease term as per paragraph 23 of Accounting Standard (AS) 19, ‘Leases’.5. In support of the company’s view, the querist has quoted the definition of ‘lease term’ as given in AS 19: 
“Theleasetermisthenon-cancellableperiodforwhichthelesseehasagreedtotakeonleasetheassettogetherwithanyfurtherperiodsforwhichthelesseehastheoptiontocontinuetheleaseoftheasset,withorwithoutfurtherpayment,whichoptionattheinceptionoftheleaseitis reasonablycertainthatthelesseewillexercise.” 
The company believes that to qualify under the above definition, there has to be a ‘non-cancellable lease term together with any further periods forwhich the lessee has the option to continue the lease’. Therefore, in the view of the querist, the definition of ‘lease term’ should not apply to leaseagreements of the type mentioned in paragraph 3(i) and (iii) above but will apply to lease agreements of the type mentioned in paragraph 3(ii) only.
B. Query
6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:(i) What should be the lease term in the case of second lease agreement?(ii) Whether there is a need to equalise rent over the lease term as per AS 19, if the option to terminate the agreement lies with(a) any of the parties (in case of the first lease agreement).(b) only with lessee (in case of the second lease agreement).(iii) Whether there is a need to equalise rent over the lease term as there is no lock-in-period (in case of lease agreements of the type mentioned inparagraph 3(i) and (iii) above) as per the definition of ‘lease term’ given in AS 19.
C. Points considered by the Committee
7. The Committee notes that the basic issues raised in the query relate to determination of lease term and whether there is a need to equalise rent overthe lease term. The Committee has, therefore, answered only these issues and has not gone into the specific cases under the two lease agreements citedby the querist in the absence of the relevant information with respect to both the agreements. The Committee presumes from the Facts of the Case thatthe lease under both the cases is an operating lease.8. The Committee notes the following definitions from AS 19: 
“Theleasetermisthenon-cancellableperiodforwhichthelesseehasagreedtotakeonleasetheassettogetherwithanyfurtherperiodsforwhichthelesseehastheoptiontocontinuetheleaseoftheasset,withorwithoutfurtherpayment,whichoptionattheinceptionoftheleaseitis
Page 3 of 5Query No8/31/2012http://220.227.161.86/eac/eacfinal/vol29/6.html

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