Chapter 5: Asset Based Accounting Standards - Test 3: answer key

Question 1 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. Meridian Precision Ltd. manufactures specialised industrial components and prepares its financial statements on 31 March 2027. On 1 April 2026, the company entered into a four-year non-cancellable lease agreement with Apex Leasing Ltd. for a customised automated production machine. The machine's fair value at inception was ₹12.00 lakh, and its estimated economic life was five years. The machine can be used by other manufacturers only after substantial technical modifications. Legal ownership will not transfer to Meridian at the end of the lease, and no purchase option is available. The lease agreement requires four equal annual payments of ₹3.50 lakh, payable at the end of each year. Meridian has additionally assured a residual value of ₹1.00 lakh payable at the end of the fourth year. The rate of interest implicit in the lease is 10% per annum. For this calculation, the applicable present value factors are: Year 1: 0.9091; Year 2: 0.8264; Year 3: 0.7513; Year 4: 0.6830. Meridian's Balance Sheet extract at 31 March 2026 disclosed owned machinery of ₹85.00 lakh and secured borrowings of ₹32.00 lakh. The finance director proposes treating the annual lease payment as an ordinary operating expense, arguing that the company does not acquire legal ownership of the equipment. The machine was available for use immediately on 1 April 2026. Meridian intends to use the machine throughout the contractual lease period and return it to Apex Leasing Ltd. at the expiry of the agreement. There is no reasonable certainty that ownership will be obtained. Assume nil residual value for depreciation purposes in the lessee's books. The company follows the straight-line method for similar owned machinery. The first annual lease instalment was paid on 31 March 2027. The finance controller has requested the correct initial recognition, subsequent allocation of lease payments and depreciation treatment under AS 19.

What is the appropriate classification of the lease entered into by Meridian Precision Ltd. on 1 April 2026?

1. Operating lease because legal ownership does not transfer.
2. Finance lease because the lease covers a major part of economic life. (correct answer)
3. Operating lease because the assured residual value is payable.
4. Finance lease only if the lessee exercises a purchase option.

Answer: B — Finance lease because the lease covers a major part of economic life.

Explanation. The lease term is four years against an economic life of five years, covering 80% of the economic life. A lease covering the major part of an asset's economic life normally qualifies as a finance lease under AS 19 para 8(c). Legal ownership need not transfer for finance-lease classification. Further, the specialised nature of the machine is an additional finance-lease indicator under para 8(e). Option (a) incorrectly treats legal ownership as the sole classification criterion.

Where it goes wrong. Assuming that a lease must transfer legal ownership to qualify as a finance lease.

Authority. AS 19 paras 5-8; AS 19 para 8(c)

Question 2 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

What is the initial amount at which Meridian Precision Ltd. should recognise the leased machine and corresponding lease liability on 1 April 2026?

1. ₹11.7773 lakh (correct answer)
2. ₹12.0000 lakh
3. ₹13.7773 lakh
4. ₹14.0000 lakh

Answer: A — ₹11.7773 lakh

Explanation. Present value of four annual rentals is ₹3.50 lakh × (0.9091 + 0.8264 + 0.7513 + 0.6830) = ₹11.0943 lakh. Present value of the assured residual value is ₹1.00 lakh × 0.6830 = ₹0.6830 lakh. Total present value is ₹11.7773 lakh. This is lower than the fair value of ₹12.00 lakh. Under AS 19 para 11, both asset and liability are initially recognised at ₹11.7773 lakh, not at the undiscounted rentals or fair value.

Where it goes wrong. Recognising the leased asset at fair value without comparing it with the present value of minimum lease payments.

Authority. AS 19 para 3.7; AS 19 para 11

Question 3 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

What are the finance charge and reduction in outstanding lease liability respectively for the first year ended 31 March 2027?

1. ₹2.32227 lakh and ₹1.17773 lakh.
2. ₹0.94551 lakh and ₹2.55449 lakh.
3. ₹3.50000 lakh and Nil.
4. ₹1.17773 lakh and ₹2.32227 lakh. (correct answer)

Answer: D — ₹1.17773 lakh and ₹2.32227 lakh.

Explanation. Opening lease liability is ₹11.7773 lakh. Finance charge for the first year is ₹11.7773 lakh × 10% = ₹1.17773 lakh. The annual rental is ₹3.50 lakh; therefore, principal reduction is ₹3.50 − ₹1.17773 = ₹2.32227 lakh. The outstanding liability after payment becomes ₹9.45503 lakh. AS 19 para 16 requires payments to be split between finance charge and principal reduction. Treating the entire rental as expense overstates finance cost.

Where it goes wrong. Treating the full annual lease payment as finance expense rather than separating principal repayment.

Authority. AS 19 para 16

Question 4 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

What depreciation should Meridian Precision Ltd. charge on the leased machine for the year ended 31 March 2027?

1. ₹2.35546 lakh
2. ₹1.96288 lakh
3. ₹2.94433 lakh (correct answer)
4. ₹1.17773 lakh

Answer: C — ₹2.94433 lakh

Explanation. Since there is no reasonable certainty that Meridian will obtain ownership, the leased asset must be depreciated over the shorter of its useful life and lease term. The shorter period is four years. Depreciation is ₹11.7773 lakh ÷ 4 = ₹2.944325 lakh, approximately ₹2.94433 lakh. The assured residual value payable to the lessor does not extend the lessee's period of use. Charging depreciation over the five-year economic life would contravene AS 19 para 19.

Where it goes wrong. Using the asset's full economic life when the lessee is not reasonably certain to obtain ownership.

Authority. AS 19 paras 18-19

Question 5 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

Scenario. Finlease Capital Ltd. is engaged in providing machinery and equipment financing to industrial customers. Its Balance Sheet at 31 March 2026 disclosed finance lease receivables of ₹42.00 lakh and unearned finance income of ₹8.50 lakh relating to earlier agreements. On 1 April 2026, the company entered into a finance lease arrangement with Nova Engineering Pvt. Ltd. for a specialised machine. The contractual period is three years. The lessee must pay annual rentals of ₹3.50 lakh at the end of each year. Nova Engineering has assured a residual value of ₹0.50 lakh payable at the end of the third year. The lessor expects an additional unguaranteed residual value of ₹0.50 lakh at the end of the lease term. The fair value of the equipment at inception is ₹9.45510 lakh. The interest rate implicit in the lease is 10% per annum. The present value factors at 10% are 0.9091, 0.8264 and 0.7513 for years one, two and three respectively. The equipment is highly customised and cannot be used by another manufacturer without substantial modification. Finlease Capital Ltd. is not the manufacturer or dealer of the equipment; it acquired the machine specifically for leasing. All minimum lease rentals and the assured residual value are contractually payable, and the lessee has taken possession of the machine on 1 April 2026. The first annual lease rental of ₹3.50 lakh was received on 31 March 2027. The finance department proposes crediting the entire rental to income because the company has received the amount in cash. The accounts manager has instead suggested separating the principal recovery and finance income using a constant periodic rate of return on the outstanding net investment. The audit committee requires the calculation of gross investment, unearned finance income, net investment and finance income for the first accounting year.

What is the gross investment in the lease in the books of Finlease Capital Ltd. on 1 April 2026?

1. ₹10.50 lakh
2. ₹11.00 lakh
3. ₹11.50 lakh (correct answer)
4. ₹9.45510 lakh

Answer: C — ₹11.50 lakh

Explanation. Gross investment comprises minimum lease payments from the lessor's standpoint plus unguaranteed residual value. Minimum lease payments are annual rentals of ₹3.50 lakh × 3 years = ₹10.50 lakh plus assured residual value of ₹0.50 lakh. Adding unguaranteed residual value of ₹0.50 lakh gives gross investment of ₹11.50 lakh. Option (d) represents the discounted net investment, not the gross investment, while omitting either residual component understates the lessor's total contractual and residual inflows.

Where it goes wrong. Confusing the discounted net investment with the undiscounted gross investment.

Authority. AS 19 paras 3.7 and 3.14

Question 6 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

What is the unearned finance income included in the gross investment at inception?

1. ₹1.54490 lakh
2. ₹2.04490 lakh (correct answer)
3. ₹2.50000 lakh
4. ₹1.95510 lakh

Answer: B — ₹2.04490 lakh

Explanation. Gross investment is ₹11.50 lakh. Present value of rentals is ₹3.50 × 2.4868 = ₹8.70380 lakh; present value of assured residual value is ₹0.50 × 0.7513 = ₹0.37565 lakh. Present value of unguaranteed residual value is also ₹0.37565 lakh. Total present value is ₹9.45510 lakh. Unearned finance income is ₹11.50 − ₹9.45510 = ₹2.04490 lakh. It is not recognised immediately as income because it is earned over the lease term.

Where it goes wrong. Calculating unearned finance income without discounting both assured and unguaranteed residual values.

Authority. AS 19 paras 3.14-3.16

Question 7 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

What amount should Finlease Capital Ltd. recognise as the net investment in the finance lease at inception?

1. ₹9.45510 lakh (correct answer)
2. ₹11.50000 lakh
3. ₹10.00000 lakh
4. ₹2.04490 lakh

Answer: A — ₹9.45510 lakh

Explanation. Net investment equals gross investment less unearned finance income. It is ₹11.50 lakh − ₹2.04490 lakh = ₹9.45510 lakh. This also represents the present value of minimum lease payments and unguaranteed residual value at the interest rate implicit in the lease. Under AS 19 para 26, the lessor recognises a finance lease receivable at the net investment amount. Showing gross investment as the receivable would include finance income that has not yet been earned.

Where it goes wrong. Recognising gross investment as the balance-sheet receivable instead of deducting unearned finance income.

Authority. AS 19 paras 3.15-3.16; AS 19 para 26

Question 8 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

What finance income should Finlease Capital Ltd. recognise for the year ended 31 March 2027, before adjusting for receipt of the first rental?

1. ₹1.15000 lakh
2. ₹0.50000 lakh
3. ₹0.70000 lakh
4. ₹0.94551 lakh (correct answer)

Answer: D — ₹0.94551 lakh

Explanation. Finance income is calculated using the constant periodic rate of return on the opening net investment. Opening net investment is ₹9.45510 lakh and the implicit interest rate is 10%. Therefore, first-year finance income is ₹9.45510 lakh × 10% = ₹0.94551 lakh. The rental received of ₹3.50 lakh contains both principal recovery and finance income. Crediting the entire receipt to income would incorrectly recognise repayment of principal as revenue under AS 19 para 28.

Where it goes wrong. Recognising the entire rental receipt as finance income instead of applying the implicit rate to the opening net investment.

Authority. AS 19 paras 26-29

Question 9 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

Scenario. Crestline Retail Ltd. operates a chain of premium retail stores and prepares financial statements on 31 March 2027. On 1 April 2026, it entered into a three-year non-cancellable operating lease for a warehouse owned by Harbour Estates Ltd. The contractual rentals payable by Crestline are ₹1.20 lakh in the first year, ₹1.50 lakh in the second year and ₹1.80 lakh in the third year. The warehouse provides substantially equal benefits throughout the contractual period, and there are no renewal or purchase options. The first rental of ₹1.20 lakh was paid on 31 March 2027. Harbour Estates Ltd. acquired the warehouse for ₹9.00 lakh. Its expected useful life is fifteen years, with nil residual value. Harbour leased the property to Crestline without transferring substantially all risks and rewards of ownership. Harbour's accounting policy is to depreciate similar buildings using the straight-line method. Its financial statements separately disclose investment property and property held for operating-lease arrangements. During the same year, Crestline also entered into a sale-and-leaseback arrangement for a specialised packaging machine. The machine had a carrying amount of ₹48.00 lakh immediately before disposal and was sold on 1 April 2026 for ₹60.00 lakh. The machine was subsequently leased back under a four-year agreement. Its remaining useful life was estimated at seven years. No title transfer or purchase option was provided, but the equipment was customised so that only Crestline could use it without major modifications. The depreciation pattern is straight-line, and the company expects to use the machine for the entire leaseback period. The finance director proposes immediately recognising the entire ₹12.00 lakh excess sale proceeds as profit and recording warehouse rental expense only when the contractual payments fall due. The auditor has requested the appropriate treatment of the operating lease, lease equalisation, depreciation by the lessor and sale-and-leaseback profit under AS 19.

What operating lease expense should Crestline Retail Ltd. recognise for the year ended 31 March 2027?

1. ₹1.50 lakh (correct answer)
2. ₹1.20 lakh
3. ₹1.80 lakh
4. ₹1.35 lakh

Answer: A — ₹1.50 lakh

Explanation. Total lease payments over the three-year term are ₹1.20 + ₹1.50 + ₹1.80 = ₹4.50 lakh. Since the warehouse provides substantially equal benefits over the lease term, annual expense is ₹4.50 ÷ 3 = ₹1.50 lakh. The fact that the actual first-year payment is only ₹1.20 lakh does not alter the straight-line expense requirement. The difference is accounted for through lease equalisation. Recognising only ₹1.20 lakh would misstate the expense for the year.

Where it goes wrong. Recognising operating lease expense strictly according to contractual cash payments instead of the applicable straight-line basis.

Authority. AS 19 paras 23-24

Question 10 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

What is the closing balance of the lease equalisation account in Crestline Retail Ltd.'s books immediately after recording the first year's rental payment and lease expense?

1. ₹0.30 lakh debit balance.
2. ₹0.30 lakh credit balance. (correct answer)
3. ₹0.60 lakh debit balance.
4. ₹0.60 lakh credit balance.

Answer: B — ₹0.30 lakh credit balance.

Explanation. Crestline recognises annual lease expense of ₹1.50 lakh but pays only ₹1.20 lakh during the first year. The shortfall is ₹0.30 lakh. Since the expense exceeds the rental paid, the difference is credited to the lease equalisation account, representing an accrued liability. This balance will be reversed as higher rentals become payable in later years and the total contractual rent is progressively settled. Treating it as an asset would reverse the relationship between expense and payment.

Where it goes wrong. Recording a debit lease equalisation balance when recognised expense exceeds the rental payable.

Authority. AS 19 paras 23-24

Question 11 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

What should be the carrying amount of Harbour Estates Ltd.'s warehouse in its Balance Sheet at 31 March 2027, after charging depreciation for the first year?

1. ₹9.00 lakh
2. ₹8.40 lakh (correct answer)
3. ₹8.10 lakh
4. ₹8.70 lakh

Answer: B — ₹8.40 lakh

Explanation. In an operating lease, the lessor continues to recognise the leased asset under fixed assets. Annual depreciation is ₹9.00 lakh ÷ 15 years = ₹0.60 lakh. Therefore, the carrying amount after the first year is ₹9.00 − ₹0.60 = ₹8.40 lakh. Harbour also recognises lease income on a straight-line basis over the lease term under AS 19 para 40. Derecognising the warehouse merely because it has been leased would be incorrect.

Where it goes wrong. Derecognising an asset in the lessor's books merely because it is provided under an operating lease.

Authority. AS 19 paras 39-43

Question 12 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

What amount of the deferred profit on the packaging machine sale-and-leaseback transaction should Crestline Retail Ltd. recognise in its Statement of Profit and Loss for the year ended 31 March 2027?

1. ₹12.00 lakh
2. ₹4.00 lakh
3. ₹6.00 lakh
4. ₹3.00 lakh (correct answer)

Answer: D — ₹3.00 lakh

Explanation. The machine is specialised and can be used only by Crestline without major modifications; consequently, the leaseback is a finance lease. Excess sale proceeds over carrying amount are ₹60 − ₹48 = ₹12 lakh. Under AS 19 para 48, this profit is deferred and amortised over the lease term in proportion to depreciation. The asset is depreciated over the shorter four-year lease term, so annual depreciation is straight-line. Annual deferred profit amortisation is ₹12 lakh ÷ 4 = ₹3 lakh. Recognising the full gain immediately is incorrect.

Where it goes wrong. Recognising the entire excess sale proceeds as immediate profit when the sale-and-leaseback arrangement results in a finance lease.

Authority. AS 19 paras 8(e) and 47-49

Question 13 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

Scenario. A leasing arrangement provides for a three-year lease term, no transfer of legal ownership and no purchase option. The leased equipment has an economic life of eight years, and the present value of minimum lease payments is only 68% of the asset's fair value. However, the equipment is custom-designed and can be used only by the lessee without substantial modification. How should the lease be classified?

A leasing arrangement provides for a three-year lease term, no transfer of legal ownership and no purchase option. The leased equipment has an economic life of eight years, and the present value of minimum lease payments is only 68% of the asset's fair value. However, the equipment is custom-designed and can be used only by the lessee without substantial modification. How should the lease be classified?

1. Operating lease because the lease term is shorter than economic life.
2. Operating lease because present value is below fair value.
3. Finance lease because the asset is specialised for the lessee. (correct answer)
4. Operating lease because legal ownership does not transfer.

Answer: C — Finance lease because the asset is specialised for the lessee.

Explanation. AS 19 para 8(e) identifies an asset of a specialised nature, usable only by the lessee without major modifications, as an indicator normally leading to finance-lease classification. The other facts do not negate this criterion. A finance lease does not necessarily require transfer of legal ownership or a lease term equal to the asset's complete economic life. Therefore, the specialised nature of the equipment is decisive despite the lower present value of minimum lease payments.

Where it goes wrong. Treating the absence of ownership transfer or a short lease term as conclusive evidence of an operating lease.

Authority. AS 19 paras 5-8; AS 19 para 8(e)

Question 14 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. A lease originally classified as a finance lease is reassessed after two years. Which of the following events, by itself, does not require a new lease classification?

A lease originally classified as a finance lease is reassessed after two years. Which of the following events, by itself, does not require a new lease classification?

1. A revised estimate of the leased asset's economic life. (correct answer)
2. A contractual amendment changing the lease term and purchase provisions.
3. A renegotiation of the assured residual value and rental structure.
4. A contractual modification that would have changed the original classification.

Answer: A — A revised estimate of the leased asset's economic life.

Explanation. AS 19 para 10 requires lease classification at inception. A subsequent agreement modifying contractual provisions, other than a renewal, which would have produced a different classification if originally applicable is treated as a new agreement over its revised term. However, revised estimates of economic life or residual value and changes in circumstances do not result in a new classification. Hence option (a) does not trigger reclassification by itself.

Where it goes wrong. Confusing a subsequent change in accounting estimates with a contractual modification that requires treatment as a new lease agreement.

Authority. AS 19 para 10

Question 15 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

Scenario. A company takes equipment on finance lease for three years. The fair value at inception is ₹15.00 lakh. The annual rentals payable at each year-end are ₹4.00 lakh, and the lessee guarantees a residual value of ₹2.00 lakh payable at the end of the third year. The interest rate implicit in the lease is 10%. Present value factors for years one, two and three are 0.9091, 0.8264 and 0.7513. What is the initial amount recognised as leased asset and lease liability?

A company takes equipment on finance lease for three years. The fair value at inception is ₹15.00 lakh. The annual rentals payable at each year-end are ₹4.00 lakh, and the lessee guarantees a residual value of ₹2.00 lakh payable at the end of the third year. The interest rate implicit in the lease is 10%. Present value factors for years one, two and three are 0.9091, 0.8264 and 0.7513. What is the initial amount recognised as leased asset and lease liability?

1. ₹15.0000 lakh
2. ₹11.4498 lakh (correct answer)
3. ₹13.4498 lakh
4. ₹12.0000 lakh

Answer: B — ₹11.4498 lakh

Explanation. Present value of annual rentals is ₹4.00 lakh × (0.9091 + 0.8264 + 0.7513) = ₹9.9472 lakh. Present value of assured residual value is ₹2.00 lakh × 0.7513 = ₹1.5026 lakh. Total present value of minimum lease payments is ₹11.4498 lakh. This is lower than fair value of ₹15.00 lakh; accordingly, the asset and liability are initially recognised at ₹11.4498 lakh under AS 19 para 11.

Where it goes wrong. Ignoring the assured residual value when computing present value of minimum lease payments.

Authority. AS 19 para 3.7; AS 19 para 11

Question 16 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. A finance lease has an opening lease liability of ₹25.00 lakh. The implicit interest rate is 9% per annum, and the first annual instalment of ₹6.00 lakh is payable at the end of the year. What is the closing lease liability after payment of the first instalment?

A finance lease has an opening lease liability of ₹25.00 lakh. The implicit interest rate is 9% per annum, and the first annual instalment of ₹6.00 lakh is payable at the end of the year. What is the closing lease liability after payment of the first instalment?

1. ₹21.75 lakh
2. ₹22.00 lakh
3. ₹19.00 lakh
4. ₹21.25 lakh (correct answer)

Answer: D — ₹21.25 lakh

Explanation. Finance charge for the year is ₹25.00 lakh × 9% = ₹2.25 lakh. Out of the ₹6.00 lakh payment, principal reduction is ₹6.00 − ₹2.25 = ₹3.75 lakh. Closing lease liability is ₹25.00 − ₹3.75 = ₹21.25 lakh. The incorrect ₹19.00 lakh option treats the whole instalment as principal repayment, ignoring the finance charge required under AS 19 para 16.

Where it goes wrong. Reducing the lease liability by the full instalment without first recognising finance charge.

Authority. AS 19 para 16

Question 17 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

Scenario. A lessee recognises a leased asset at ₹11.4498 lakh under a finance lease. The lease term is three years, estimated useful life is six years and there is no reasonable certainty that ownership will transfer to the lessee. Assuming nil residual value, what is the annual straight-line depreciation?

A lessee recognises a leased asset at ₹11.4498 lakh under a finance lease. The lease term is three years, estimated useful life is six years and there is no reasonable certainty that ownership will transfer to the lessee. Assuming nil residual value, what is the annual straight-line depreciation?

1. ₹3.8166 lakh (correct answer)
2. ₹1.9083 lakh
3. ₹2.8625 lakh
4. ₹2.2899 lakh

Answer: A — ₹3.8166 lakh

Explanation. Where ownership is not reasonably certain, AS 19 requires depreciation over the shorter of the lease term and useful life. The shorter period is three years. Annual depreciation is ₹11.4498 lakh ÷ 3 = ₹3.8166 lakh. Applying the six-year useful life would result in ₹1.9083 lakh annual depreciation, incorrectly extending the depreciation period beyond the period for which ownership or continued use is assured.

Where it goes wrong. Depreciating a finance-leased asset over its entire useful life when ownership is not reasonably certain.

Authority. AS 19 paras 18-19

Question 18 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. A lessor has a gross investment in a finance lease of ₹16.80 lakh. The present value of minimum lease payments and unguaranteed residual value, discounted at the interest rate implicit in the lease, is ₹14.25 lakh. What is the unearned finance income?

A lessor has a gross investment in a finance lease of ₹16.80 lakh. The present value of minimum lease payments and unguaranteed residual value, discounted at the interest rate implicit in the lease, is ₹14.25 lakh. What is the unearned finance income?

1. ₹16.80 lakh
2. ₹14.25 lakh
3. ₹2.55 lakh (correct answer)
4. ₹3.15 lakh

Answer: C — ₹2.55 lakh

Explanation. Unearned finance income is the difference between gross investment and the present value of minimum lease payments plus the unguaranteed residual value, discounted at the implicit interest rate. Therefore, unearned finance income is ₹16.80 − ₹14.25 = ₹2.55 lakh. The ₹14.25 lakh is the net investment and not unearned income. The difference is recognised systematically over the lease term as finance income under AS 19.

Where it goes wrong. Mistaking the lessor's net investment for unearned finance income.

Authority. AS 19 paras 3.14-3.16

Question 19 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. At the commencement of a finance lease, a lessor has a net investment of ₹14.25 lakh. The implicit rate is 12% per annum. At the end of the first year, the lessor receives an annual rental of ₹4.80 lakh. What is the closing net investment after recording the first year's finance income and rental receipt?

At the commencement of a finance lease, a lessor has a net investment of ₹14.25 lakh. The implicit rate is 12% per annum. At the end of the first year, the lessor receives an annual rental of ₹4.80 lakh. What is the closing net investment after recording the first year's finance income and rental receipt?

1. ₹12.540 lakh
2. ₹10.950 lakh
3. ₹9.450 lakh
4. ₹11.160 lakh (correct answer)

Answer: D — ₹11.160 lakh

Explanation. Finance income is ₹14.25 lakh × 12% = ₹1.71 lakh. Before receiving the rental, net investment becomes ₹14.25 + ₹1.71 = ₹15.96 lakh. The ₹4.80 lakh rental reduces the receivable, resulting in closing net investment of ₹11.16 lakh. The lessor recognises finance income on the outstanding net investment, not on the gross investment or the rental received. This follows the constant periodic return requirement of AS 19 para 28.

Where it goes wrong. Calculating finance income on gross investment or deducting the rental without first adding finance income.

Authority. AS 19 paras 26-29

Question 20 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

Scenario. A company takes a machine on a three-year operating lease. Contractual rentals are ₹1.00 lakh, ₹2.00 lakh and ₹3.00 lakh respectively. A systematic output-based pattern is more representative of the benefits received. Expected output is 20,000 units, 30,000 units and 50,000 units respectively. The first-year rental of ₹1.00 lakh is paid. What should be recognised in the first year?

A company takes a machine on a three-year operating lease. Contractual rentals are ₹1.00 lakh, ₹2.00 lakh and ₹3.00 lakh respectively. A systematic output-based pattern is more representative of the benefits received. Expected output is 20,000 units, 30,000 units and 50,000 units respectively. The first-year rental of ₹1.00 lakh is paid. What should be recognised in the first year?

1. ₹1.00 lakh expense and nil equalisation balance.
2. ₹1.20 lakh expense and ₹0.20 lakh credit equalisation balance. (correct answer)
3. ₹2.00 lakh expense and ₹1.00 lakh debit equalisation balance.
4. ₹1.50 lakh expense and ₹0.50 lakh credit equalisation balance.

Answer: B — ₹1.20 lakh expense and ₹0.20 lakh credit equalisation balance.

Explanation. Total contractual rentals are ₹6.00 lakh and total expected output is 1,00,000 units. The first-year output proportion is 20%, so rent expense is ₹6.00 lakh × 20% = ₹1.20 lakh. The first-year rental paid is ₹1.00 lakh. Since recognised expense exceeds cash paid by ₹0.20 lakh, a credit balance is recorded in lease equalisation. The output-based method is appropriate because it better represents the pattern of benefits received.

Where it goes wrong. Automatically applying straight-line expense recognition even when a more representative systematic basis is available.

Authority. AS 19 paras 23-24

Question 21 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. A lessor gives a warehouse having cost ₹30 lakh and useful life of ten years on an operating lease. The annual rentals are ₹4 lakh, ₹5 lakh and ₹6 lakh over three years. Assume the leased asset's economic benefits are consumed evenly over time and its residual value is nil. What is the net contribution to the lessor's Statement of Profit and Loss for the first year from lease income and depreciation, before other expenses?

A lessor gives a warehouse having cost ₹30 lakh and useful life of ten years on an operating lease. The annual rentals are ₹4 lakh, ₹5 lakh and ₹6 lakh over three years. Assume the leased asset's economic benefits are consumed evenly over time and its residual value is nil. What is the net contribution to the lessor's Statement of Profit and Loss for the first year from lease income and depreciation, before other expenses?

1. ₹5.00 lakh income less ₹4.00 lakh depreciation.
2. ₹4.00 lakh income less ₹3.00 lakh depreciation.
3. ₹2.00 lakh net income after depreciation. (correct answer)
4. ₹3.00 lakh net loss after depreciation.

Answer: C — ₹2.00 lakh net income after depreciation.

Explanation. Total contractual rentals are ₹15.00 lakh over three years. The straight-line rental income is ₹15.00 ÷ 3 = ₹5.00 lakh annually. The lessor continues to recognise the warehouse as an asset and charges depreciation of ₹30.00 lakh ÷ 10 = ₹3.00 lakh annually. Therefore, net contribution is ₹5.00 − ₹3.00 = ₹2.00 lakh. The cash rental of ₹4.00 lakh received in the first year does not determine the income recognised under the straight-line basis.

Where it goes wrong. Recognising rental income according to cash receipts instead of the straight-line pattern while also forgetting depreciation.

Authority. AS 19 paras 39-43

Question 22 · 2 marks · Chapter 5: Asset Based Accounting Standards · medium

Scenario. A company sells machinery having a carrying amount of ₹26 lakh for ₹30 lakh and leases it back under an operating lease. The sale price is equal to the fair value on the transaction date. What is the appropriate treatment of the gain?

A company sells machinery having a carrying amount of ₹26 lakh for ₹30 lakh and leases it back under an operating lease. The sale price is equal to the fair value on the transaction date. What is the appropriate treatment of the gain?

1. Recognise the ₹4 lakh gain immediately in profit or loss. (correct answer)
2. Defer the ₹4 lakh gain and amortise it over the lease term.
3. Recognise ₹2 lakh immediately and defer ₹2 lakh.
4. Defer the entire ₹4 lakh gain until the lease terminates.

Answer: A — Recognise the ₹4 lakh gain immediately in profit or loss.

Explanation. The gain on sale is ₹30 lakh − ₹26 lakh = ₹4 lakh. Since the leaseback is an operating lease and the sale price equals fair value, the transaction is treated as a normal sale. Accordingly, the gain is recognised immediately in the Statement of Profit and Loss. Deferral and amortisation are required in specified sale-and-leaseback situations, including finance leasebacks or transactions involving sale prices above fair value.

Where it goes wrong. Applying the deferred-profit rule for finance leasebacks to an operating leaseback established at fair value.

Authority. AS 19 paras 47 and 50-51

Question 23 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. An entity sells an asset having a carrying amount of ₹70 lakh for ₹112 lakh and leases it back under an operating lease. The fair value of the asset on the sale date is ₹100 lakh. Which treatment is appropriate under AS 19?

An entity sells an asset having a carrying amount of ₹70 lakh for ₹112 lakh and leases it back under an operating lease. The fair value of the asset on the sale date is ₹100 lakh. Which treatment is appropriate under AS 19?

1. Recognise ₹42 lakh immediately as profit.
2. Recognise ₹30 lakh immediately and defer ₹12 lakh. (correct answer)
3. Defer ₹42 lakh and amortise it over the leaseback period.
4. Recognise ₹12 lakh immediately and defer ₹30 lakh.

Answer: B — Recognise ₹30 lakh immediately and defer ₹12 lakh.

Explanation. The profit represented by fair value over carrying amount is ₹100 − ₹70 = ₹30 lakh. Since sale proceeds exceed fair value by ₹112 − ₹100 = ₹12 lakh, the excess over fair value must be deferred and amortised over the period for which the asset is expected to be used. Accordingly, ₹30 lakh is recognised immediately and ₹12 lakh is deferred. Recognising the entire ₹42 lakh immediately would incorrectly recognise consideration exceeding fair value.

Where it goes wrong. Recognising the entire sale proceeds excess over carrying amount immediately without separating the amount above fair value.

Authority. AS 19 paras 50 and 52

Question 24 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. A company sells an asset with a carrying amount of ₹88 lakh for ₹82 lakh and leases it back under an operating lease. The fair value is ₹90 lakh. The sale-and-leaseback agreement establishes that the entire ₹6 lakh loss is compensated by future lease rentals below market price. The asset is expected to be used over a further three years, and the future rental benefits are equal in each year. How should the loss be treated?

A company sells an asset with a carrying amount of ₹88 lakh for ₹82 lakh and leases it back under an operating lease. The fair value is ₹90 lakh. The sale-and-leaseback agreement establishes that the entire ₹6 lakh loss is compensated by future lease rentals below market price. The asset is expected to be used over a further three years, and the future rental benefits are equal in each year. How should the loss be treated?

1. Recognise the entire ₹6 lakh loss immediately.
2. Recognise ₹4 lakh immediately and defer ₹2 lakh.
3. Defer the entire loss without subsequent amortisation.
4. Defer ₹6 lakh and amortise ₹2 lakh per year. (correct answer)

Answer: D — Defer ₹6 lakh and amortise ₹2 lakh per year.

Explanation. The sale proceeds are ₹82 lakh against carrying amount of ₹88 lakh, giving a loss of ₹6 lakh. The fair value of ₹90 lakh exceeds carrying amount, so no additional immediate write-down is required. As the entire loss is compensated by future rentals below market price, AS 19 para 50 requires deferral and amortisation in proportion to future lease payments. With equal rental benefits over three years, annual amortisation is ₹6 ÷ 3 = ₹2 lakh.

Where it goes wrong. Recognising a compensated sale-and-leaseback loss immediately or deferring it without systematic amortisation.

Authority. AS 19 para 50

Question 25 · 2 marks · Chapter 5: Asset Based Accounting Standards · hard

Scenario. A lessee enters into a non-cancellable lease for three years. Annual fixed rentals are ₹2.40 lakh. It is reasonably certain at inception that the lessee will exercise a purchase option at the end of the third year for ₹0.45 lakh, whereas the expected fair value on that date is ₹2.00 lakh. In addition, annual service charges of ₹0.18 lakh, reimbursable taxes of ₹0.12 lakh and contingent rentals based on production of ₹0.10 lakh are payable. What is the total minimum lease payment from the lessee's standpoint?

A lessee enters into a non-cancellable lease for three years. Annual fixed rentals are ₹2.40 lakh. It is reasonably certain at inception that the lessee will exercise a purchase option at the end of the third year for ₹0.45 lakh, whereas the expected fair value on that date is ₹2.00 lakh. In addition, annual service charges of ₹0.18 lakh, reimbursable taxes of ₹0.12 lakh and contingent rentals based on production of ₹0.10 lakh are payable. What is the total minimum lease payment from the lessee's standpoint?

1. ₹7.65 lakh (correct answer)
2. ₹8.85 lakh
3. ₹7.20 lakh
4. ₹8.40 lakh

Answer: A — ₹7.65 lakh

Explanation. Fixed rentals total ₹2.40 lakh × 3 = ₹7.20 lakh. The purchase option price of ₹0.45 lakh is included because it is sufficiently below the expected fair value of ₹2.00 lakh and its exercise is reasonably certain at inception. Service charges, reimbursable taxes and contingent rentals are excluded from minimum lease payments. Therefore, total minimum lease payments are ₹7.20 + ₹0.45 = ₹7.65 lakh. Including all contractual cash payments would wrongly include service, tax and contingent components.

Where it goes wrong. Including service costs, reimbursable taxes and contingent rentals, or excluding a reasonably certain bargain purchase option.

Authority. AS 19 para 3.7