Inception of Lease

Lease is considered one of the toughest standards in the IFRS handbook. It is overwhelming with the related technical jargon, which we will attempt to explain a little in the future posts.

Inception of lease

• Inception of lease is a point of time. It is measured by the comparison of two dates. One is the date of signing of the lease agreement and the other being the date when the respective parties get engaged to the core covenants of the lease agreement. The earliest of the aforementioned dates would be considered as a point of inception of the lease.
• In the case of the finance lease, the point of inception of the lease is central to the recognition of transaction in the books of accounts. The transaction will be translated into a leased asset and the corresponding liability.
• However in relation to operating Lease, it is the point of recording of the lease rental expenses in the statement of comprehensive income.

Students often confuse the Lease agreements with the normal renting out agreements. If we observe, the Lease agreements can be categorized into two broad types. One is the Finance Lease and the other is operational lease. Normal Renting out agreements are agreements of the operational lease type. Let recapitulate the core difference between the two.

Finance Lease in contrast to Operational Lease

There is consensus that Lease affords the right to employ the asset in the business to the Lessee, but the ownership is not transferred. Now if the Lease agreement is substantially titled towards Sale (that is transferring the ownership) it is finance lease. On the other hand, in case of operational lease the ownership is just out of equation. So you have now grasped the key distinction point between the two broad categories.

Example 1 

Mr. George wants to purchase a new car. On account of poor liquidity, he preferred to lease the car from his Bank. Mr. George has a test drive of the car on 22nd December 2014. The lease agreement was signed on 1st January 2015. However, Mr. George paid the first lease payment on 31st January 2015. 

Here, inception of the Lease would be the date of undersigning the lease agreement that is 1st January 2015.

Example 2

Sparrow enterprises want to lease a refining plant from the Lease Company ABC. The principal terms of the lease that is

1. The Period of lease term
2. Number of lease rentals
3. The amount of the single lease rental.
4. The residual value of the Plant and
5. When asset is to be returned

are committed to by the lessor and lessee on 1st April 2014. The lease agreement is marked on 1st June 2014.

Here, the point of inception of the lease is 1st April 2014. Why? Because it is the earlier of the date of commitment to the principal terms by parties (1st April 2014) and the date of the lease agreement that is 1st June 2014.

The Point of Inception of Lease in different Standards

The related SSAP is the SSAP 21. It holds different view in relation to the Point of inception of Lease. It compares the day the asset is put into business use and the date that rentals commences to accrue.