The accountancy treatment of all leases (operating leases, finance leases and hire purchase contracts) is governed by SSAP 21 ‘Accounting for leases and hire purchase contracts’.
SSAP 21 defines a FINANCE LEASE as one which `transfers
substantially all the risks and rewards of ownership of an asset to
the lessee.' Such a transfer of risks and rewards should be
presumed to occur `if at the inception of a lease the present value
of the minimum lease payments, including any initial payment,
amounts to substantially all (normally 90% or more) of the fair
value of the leased asset'.
For accountancy purposes, a hire purchase lease is treated in
the same way as a finance lease.
SSAP 21 defines an OPERATING LEASE as any lease which is not
a finance lease.
It follows that, in practice, there can be little difference between a 91% finance lease and an 89% operating lease. There is also an element of judgment involved in arriving at the present value of the lease payments and sometimes the accounts treatment can be influenced by the result desired by the trader. For example, a lessee may be keen to get the leased asset `off balance sheet' in the hope of making the financial position of the business look better. The lessor and lessee may even exercise their judgment differently, so that one treats the deal as a finance lease (on balance sheet) and the other treats it as an operating lease (off balance sheet). However, Financial Reporting Standard 5 attempts to reduce the scope for manipulation by insisting that the parties take account of the substance of the transaction.
Under FRS 5 ‘Reporting the substance of transactions’ leases which fall just outside the definition of a finance lease under SSAP 21 may be accounted for as finance leases in order to report the substance of the transaction. FRS 5 applies to company accounts for periods ending on or after 22 September 1994.
