Sooraj Limited wishes to obtain a machine costing 30 lakhs by way of lease. The effective life of the machine is 14 years, but the company requires…

As per AS 19 'leases', a lease will be classified as finance lease if at the inception of the lease, the present value of minimum lease payment amounts to at least substantially all of the fair value of leased asset. In the given case, the implicit rate of interest is given at 15%. The present value of minimum lease payments at 15% using PV- Annuity Factor can be computed as: Annuity Factor (Year 1 to Year 3) 2.28 Present Value of minimum lease payments (3 lakhs each year) 6.84 lakhs Thus, the present value of minimum lease payments is 6.84 lakhs and the fair value of the machine is 30 lakhs. In a finance lease, the lease term should be for a major part of the economic life of the asset even if title is not transferred. However, in the given case, the effective useful life of the machine is 14 years while the lease is only for three years. Therefore, a lease agreement is an operating lease. Lease payments under an operating lease should be recognized as an expense in the statement of profit and loss on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user's benefit.