Differences between AS-19, IAS and US GAAP in respect of the principles for classifying a lease as a finance lease
Posted by Rona on March 6, 2012The phrases ?major part of economic life? and ?substantially all of the fair value? set out in criteria 3 & 4 are open to interpretation. Does it imply 60%, 80%, 95% is anybody?s guess. It is always possible that given the same set of facts the lessor and the lessee may reach different conclusions regarding the classification of a given lease. These issues have been a persistent problem in applying IAS-17 and is likely to be a problem in applying AS-19 which is modelled on IAS-17. In the US standard, a threshold of 75% or more of the useful life has been specified for classifying a lease as a finance lease, which thus creates a ?Laxman rekha? test to be applied mechanically. Further a threshold of ?the present value of the minimum lease payments equaling at least 90% of leased asset fair value? is set under the US standard, rather than the ?substantially all of the fair value of the leased asset? employed under AS-19.?
US GAAP clearly sets out the circumstances or factors which if not satisfied from the standpoint of the lessor would lead to different classifications by the lessor and the lessee. SFAS-13 stipulates that the following two conditions both need to be satisfied in addition to meeting any one of the criteria established for capitalisation determination by the lessee, before a lease could be classified as a finance lease from the standpoint of a lessor: (a) collectibility of the minimum lease payments is reasonably predictable (b) No important uncertainties surround the amount of non-reimbursable costs yet to be incurred by the lessor under the lease. Under US GAAP, therefore, if a lease transaction does not meet the criteria for classification as a sales-type lease, a direct financing lease, or a leveraged lease as specified above (by satisfying both of the above noted extra criteria), it is to be classified in the financial statements of the lessor as an operating lease. If the lessee has accounted for the lease as a capital lease, the asset being leased may appear on the balance sheet of both lessee and lessor.
The drawback of the US GAAP cook book approach is that enterprises would try to convert a finance lease ihto an operating lease by entering into lease arrangements where present value would equal to 89% and the lease period would equal to 74% of its economic life. However, AS-19 does not necessarily plug this loophole, but leaves it to the judgement of the management and the auditor.
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