Skip to main content

🎓 New resources added daily! Join over 50,000 students using Padandas

Write down the meaning and types of lease. Also, point out the criteria for identifying capital lease.

Write down the meaning and types of lease. Also, point out the criteria for identifying capital lease.

Solution

A lease is a contractual arrangement between a lessor, the owner of the property, and a lessee, the user of the property. It gives the lessee the right to use a specific asset for a stated period in return for periodic cash payments. Leasing is a popular way of financing assets, because it needs only a small initial cash outlay and its terms can be structured flexibly to meet the needs of both parties.

There are two types of lease:

  1. Operating lease: the lessee acquires the right to use an asset for a limited period only.
    1. The lessee does not record the asset or the payment obligation on its balance sheet, so it is called off-balance-sheet financing and does not worsen the debt-to-equity ratio.
    2. The lessee records lease payments as rent expense, and the lessor records them as rent revenue.
    3. Examples include renting an apartment, a shop or a car.
  2. Capital lease (financing lease): the lease transfers substantially all the benefits and risks of ownership to the lessee, so it is treated as if the lessee had bought the asset.
    1. The lessee records a lease asset and a lease obligation at the present value of the minimum lease payments.
    2. Depreciation is charged on the lease asset each year.
    3. Each lease payment is split into interest expense and a reduction of the lease obligation, using the effective interest method.

A lease is classified as a capital lease if any one of the following criteria is met:

  1. Transfer of ownership: the lease transfers ownership of the property to the lessee by the end of the lease term.
  2. Bargain purchase option: the lessee has the option to buy the asset during the lease term at a price substantially below its fair market value, and is expected to use that option.
  3. 75% of economic life: the lease term is 75% or more of the economic life of the leased property, so the lessee uses the asset for most of its useful life.
  4. 90% of fair market value: the present value of the minimum lease payments is 90% or more of the fair market value of the leased property, so the lessee has in substance paid for the asset.

Explore more questions

  1. 1.

    Describe the users of accounting information. Why do they need such information? Explain.

    Practice
  2. 2.

    The following are the financial statements of a company:

    Liabilities Last Year Current year Assets Last Year Current year
    Share capital150,000300,000Fixed assets250,000360,000
    Pref. share capital60,00090,000Investment60,00075,000
    10% bank loan75,00030,000Sundry debtors45,00060,000
    Accounts payable40,00030,000Inventories30,00075,000
    Retained earnings30,00075,000Cash at bank15,00030,000
    Prov. for dividend15,00030,000
    Prov. for tax30,00045,000
    Total400,000600,000Total400,000600,000

    Income Statement for the current year

    Particulars Rs. Rs.
    Sales300,000
    Less: Cost of goods sold120,000
    Gross profit180,000
    Less: Operating expenses (including depreciation Rs. 30,000 and interest Rs. 12,000)87,000
    Provision for tax45,000
    Provision for dividend30,000162,000
    18,000
    Add: Gain on sale of plant (cost Rs. 30,000, accumulated depreciation Rs. 15,000)12,000
    Interest on investment15,000
    Net income45,000

    Required: Cash flow statement by using direct method.

    Long question Practice
  3. 3.

    Following are the transaction of a company.

    a. Started business with cash Rs. 100,000 and bank balance Rs. 40,000.

    b. Purchased office equipment for Rs. 100,000 and paid 25% cash and balance through cheque.

    c. Purchased merchandise goods for Rs. 50,000 on account.

    d. Sold merchandise goods on account for Rs. 170,000.

    e. Received a cheque from customer Rs. 145,000 in full settlement of Rs. 150,000.

    f. Paid Rs. 45,000 to supplier by issuing a cheque after deducting 10% discount.

    g. Rs. 12,000 was paid for insurance premium.

    h. Paid electricity bill Rs. 15,000.

    i. Paid office salary Rs. 20,000.

    j. Rent paid in advance Rs. 15,000 through cheque.

    Additional Information

    a) Ending inventory Rs. 20,000.

    b) Office salary due Rs. 4,000

    c) Depreciation on office equipment @25%

    Required:

    a. Journal entries.

    b. Triple column cash book.

    c. Accounts receivable and payable account.

    d. Adjusted trial balance.

    Long question Practice
  4. 4.

    Define source of documents. Write down the objectives of the source of documents.

    Practice
  5. 5.

    (a) On Chaitra 2081, Bank Statement disclosed a balance of Rs.10,000 and Cash Book showed the balance of Rs.8,900.

    i) Undeposited cheque Rs. 3,000

    ii) Outstanding cheque Rs. 4,000.

    iii) Notes receivable and interest collected by the bank Rs. 1,000 and Rs. 200 respectively.

    iv) A customer's cheque for Rs. 1,000 was returned by the bank due to insufficient fund.

    v) Bank charge Rs. 100 for the service provided by the bank.

    Required:

    a. Bank Reconciliation Statement as on 31st Chaitra

    b. Bank balance to be reported on company's balance sheet as on 31st Chaitra.

    (b) Differentiate between accounting and accountancy.

    Long question Practice
  6. 6.

    (a) A company purchased a machine on January 1, 2023 for Rs. 90,000 and spent Rs. 10,000 on its installation. The company writes off depreciation @ 10% p.a. on straight line method. At the end of June 2025, the company sold the machine at Rs. 90,000. The books are closed on 31st December every year.

    Required: Machinery account for the first three years.

    (b) Differentiate between capital and revenue expenditures.

    Long question Practice