Tag: Investment Accounting

Lessor is the party that owns the asset and grants the lessee the right to use it for a specific period in exchange for periodic payments. The accounting treatment in the books of the lessor is essential to correctly reflect the transaction’s financial position, and it primarily follows the standards outlined by Ind AS 17 (now replaced by Ind AS 116) and IFRS 16 in certain cases. This treatment involves various entries for lease income, depreciation, and asset management.

1. Recognition of Lease Income

For a lessor, the primary income generated is the lease rent paid by the lessee. The lease income recognition follows the systematic approach over the lease term. There are two main categories of lease income, depending on the type of lease: operating lease and finance lease.

A. Operating Lease

An operating lease is one where the risks and rewards of ownership remain with the lessor. In this type of lease, the lessor continues to recognize the asset on its balance sheet and records the income over the lease term.

• Journal Entries for Operating Lease Income:
  • Receipt of lease rent:
    • Debit: Bank/Cash Account (for the amount received)
    • Credit: Lease Income Account (for the amount of lease rent)
  • Recognizing lease income: The lessor records income on a straight-line basis unless another systematic and rational method is more representative of the time pattern of the lessee’s benefit.
    • Debit: Lease Income Account
    • Credit: Unearned Rent Account (in case of advance receipts or deferred income)

This means that the lessor earns consistent revenue during the lease term, irrespective of the actual payment schedule (unless it is variable in nature).

B. Finance Lease

In a finance lease, the risks and rewards of ownership are transferred to the lessee. The lessor, therefore, recognizes the lease as a receivable equal to the net investment in the lease (i.e., the present value of lease payments plus the unguaranteed residual value). It is treated as a financing arrangement rather than a rental agreement.

• Journal Entries for Finance Lease Income:
  • Recognition of Lease Receivable (at the start of the lease):
    • Debit: Lease Receivable Account (net investment in the lease)
    • Credit: Asset Account (for the cost of the asset or its carrying amount)
  • Recognizing Interest Income (Interest on Lease Receivable):
    • Debit: Lease Receivable Account (reducing principal)
    • Credit: Interest Income Account (recognizing interest earned)
  • Lease Payments Received:
    • Debit: Bank/Cash Account (for the amount received)
    • Credit: Lease Receivable Account (reducing the principal balance)

In a finance lease, the lessor earns both interest income and lease principal payments over the lease term. This results in a front-loaded interest income pattern.

2. Depreciation of Asset

In the case of an operating lease, the lessor retains ownership of the leased asset and is responsible for depreciating the asset over its useful life. The depreciation method and the estimated useful life of the asset should comply with the lessor’s accounting policies, following standard depreciation methods like straight-line or declining balance method.

• Journal Entry for Depreciation:
  • Debit: Depreciation Expense (in the Income Statement)
  • Credit: Accumulated Depreciation (on the Balance Sheet)

The depreciation charge is recorded by the lessor for each period until the asset’s useful life is exhausted or it is sold or disposed of.

In a finance lease, the lessor may not record depreciation on the asset as the lease effectively transfers the ownership risks to the lessee. However, some lessors might continue to depreciate the asset if they do not transfer ownership entirely or have a residual interest.

3. Initial Direct Costs

In the case of a lease agreement, the lessor may incur certain initial direct costs that are directly attributable to negotiating and arranging the lease. These costs could include legal fees, commissions, and any other expenses directly related to the lease agreement.

• Journal Entry for Initial Direct Costs:
  • Debit: Lease Receivable (in case of finance lease)
  • Debit: Expense Account (in case of operating lease)
  • Credit: Bank/Cash Account

These initial direct costs are recognized over the lease term. In an operating lease, they are amortized on a straight-line basis unless a different systematic basis is appropriate.

4. Recognition of Residual Value

In both operating and finance leases, the lessor may expect to receive a residual value of the asset at the end of the lease term. If the lease has a guaranteed residual value, it is included in the lease receivable. For an operating lease, the lessor will revalue the asset based on its estimated residual value and take appropriate measures for depreciation.

5. Sale and Leaseback Transactions

In cases where a lessor sells an asset and leases it back, the transaction is treated as a sale and leaseback. The accounting treatment in this case depends on whether the transaction is classified as a finance lease or operating lease. If it is an operating lease, the sale is recognized and the leaseback terms are accounted for as a lease.

Stock Valuation refers to the process of determining the value of inventory held by a business at the end of an accounting period. Accurate stock valuation is crucial for financial reporting, profit calculation, and proper cost management. Inventory is classified as a current asset on the balance sheet, and its valuation directly affects both the cost of goods sold (COGS) and the net income of the business.

Objectives of Stock Valuation:

• Accurate Profit Determination

Proper valuation of inventory ensures accurate determination of COGS and, consequently, the correct profit or loss for the period.

• True Financial Position

Inventory is a significant asset, and its correct valuation is essential for presenting a true and fair financial position of the company.

• Efficient Cost Control

Stock valuation helps in monitoring and controlling production and operational costs by providing insights into material consumption and wastage.

• Compliance with Accounting Standards

Accurate stock valuation ensures adherence to accounting principles and standards, such as the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

Methods of Stock Valuation:

There are several methods for valuing stock, depending on the nature of the business and accounting policies adopted. The commonly used methods are:

1. First-In, First-Out (FIFO)

The FIFO method assumes that the oldest inventory items are sold first. Therefore, the ending inventory consists of the most recent purchases.

Advantages:

• Provides a realistic view of ending inventory value, as it is based on the most recent prices.
• Useful in periods of inflation, as the cost of goods sold is lower, resulting in higher profits.

Disadvantages:

• Higher profits may result in higher tax liability during inflationary periods.

Example:

Date	Units Purchased	Cost per Unit (₹)	Total Cost (₹)
1 Jan	100	10	1,000
5 Jan	200	12	2,400
Total Units Sold = 150

COGS for 150 units:

• 100 units @ ₹10 = ₹1,000
• 50 units @ ₹12 = ₹600

Total COGS = ₹1,600

2. Last-In, First-Out (LIFO)

LIFO method assumes that the most recent inventory items are sold first, and the ending inventory consists of the oldest purchases.

Advantages:

• In periods of inflation, LIFO results in higher COGS and lower profits, which can reduce tax liability.

Disadvantages:

• The ending inventory may be undervalued since it consists of older costs, which may not reflect current market prices.
• LIFO is not permitted under IFRS.

Example:

Using the same data as in the FIFO example:
COGS for 150 units:

• 150 units @ ₹12 = ₹1,800

  Total COGS = ₹1,800

3. Weighted Average Cost (WAC)

WAC method calculates the cost of ending inventory and COGS based on the average cost of all units available for sale during the period.

Formula:

Weighted Average Cost per Unit = Total Cost of Inventory / Total Units​

Example:

Using the same data:

Total units = 100 + 200 = 300

Total cost = ₹1,000 + ₹2,400 = ₹3,400

Weighted average cost per unit = ₹3,400 ÷ 300 = ₹11.33

COGS for 150 units = 150 × ₹11.33 = ₹1,699.50

Comparison of Methods

Criteria	FIFO	LIFO	WAC
Cost Flow Assumption	Oldest items sold first	Newest items sold first	Average cost
Ending Inventory Value	Higher during inflation	Lower during inflation	Moderate
Profit Impact	Higher profit	Lower profit	Average profit
Permitted by IFRS	Yes	No	Yes

Importance of Consistency

Once a method of stock valuation is adopted, it should be consistently applied across accounting periods. Changing methods frequently can distort financial results and reduce comparability. However, any change in the valuation method must be disclosed, along with its financial impact, as per accounting standards.