Accounting treatment in the books of Lessee for a Finance Lease

Creation of a new fixed asset and a corresponding

liability The Lease rental consists of two parts The lease rentals (principal) and the interest Interest has to be debited to P&L account and the principal should be deducted from the liability every year

 Apart from the above depreciation has to be

calculated every year on WDV.

 HML has entered into a lease agreement for an equipment costing Rs.750 lakh. The lease is noncancelable for a period of five years. The annual lease rentals payable in arrears amount to Rs. 300/Rs.1000. The economic life of the equipment is expected to be eight years. The HML uses WDV method and 30% rate to depreciate the equipment. The incremental borrowing rate is 16% and HML is in tax bracket of 35%

 Determine the capitalized value of the equipment and pass the relevant journal entries for capitalization Prepare a schedule showing the allocation of unexpired finance charge Prepare all relevant ledger accounts for first three years of the lease. Also show how the ledger balances will be reflected in the financial statements

 Calculation of capitalized value (value of the asset) It is the lesser of

a. cost price or b. the present value of the future lease rentals discounted at the incremental rate of borrowing

Journal entry: Debit leased equipment and Credit Lease payable Account.

Schedule showing the allocation between finance charge and principal

Yr O/s Inte Lease . Lease rest payment Liability

Interest Principal charge

List of ledger accounts to be prepared

Leased Equipment Account (Fixed asset) Depreciation and Provision for depreciation account Lease rental account Finance charges (Interest) account Lease payable account Financial statement disclosures