# BIM61055 - Leasing: General: accountancy treatment: calculating finance charge: example

The following example illustrates the accounting entries for a finance lessee and how they are calculated.

### Facts

Asset cost: £17,450; Expected life: 25 years

Finance lease:

• primary period: 5 years; rental £4,310 pa in arrears
• secondary period: 20 years; rental £50 p.a. in arrears

Lease terminated during year 7; asset sold for £15,000; rental rebate of £14,050 paid to lessee.

### Calculation of finance charge

 Step 1 - calculate total finance charge in rentals Total rentals 5 x £4,310 £21,550 20 x £50 £1,000 £22,550 Cost of asset £17,450 Total finance charge £5,100

 Step 2 - allocate finance charge to individual rentals by rule of 78 (sum of digits) 5 rentals in primary period sum of digits: 1+2+3+4+5 = 15 Year 1 5/15 x £5100* =£1,700 Year 2 4/15 x £5100 =£1,360 Year 3 3/15 x £5100 =£1,020 Year 4 2/15 x £5100 =£670 Year 5 1/15 x £5100 =£350 £5,100 * Secondary period rentals ignored on de minimis grounds.

 Step 3 - allocate rental payments to period of account Finance charge Loan repayment Total Year 1 £1,700 £2,610 £4,310 Year 2 £1,360 £2,950 £4,310 Year 3 £1,020 £3,290 £4,310 Year 4 £670 £3,640 £4,310 Year 5 £350 £3,960 £4,310 Total £5,100 £16,450 £21,550

### Accounting entries - lessee

 Balance Sheet At start Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7* Assets Leased Asset £17450 £17450 £17450 £17450 £17450 £17450 £17450 £17450 Dep’n - £(700) £(1400) £(2100) £(2800) £(3500) £(4200) £(4200) Disposal (13250) Net £17450 £16750 £16050 £15350 £14650 £13950 £13250 0 Liabilities Lease creditor £17450 £17450 £14840 £11890 £8600 £4960 £1000 £950 Repay-ment - £2610 £2950 £3290 £3640 £3960 £50 £950 Net £17450 £14840 £11890 £8600 £4960 £1000 £950 - Profit and Loss A/c Dep’n £(700) £(700) £(700) £(700) £(700) £(700) Profit on Sale £1750 Finance Charge £(1700) £(1360) £(1020) £(670) £(350) 0 0 Total £(2400) £(2060) £(1720) £(1370) £(1050) £(700) £1750 *Termination Adjustments Debit Credit Lease £950 Leased assets £13250 Creditor-Bank £14050 Profit on Sale £1750 £15000 £15000

### Cash Position

Rentals paid:5 x £4,310=£21,550
1 x £50=£50
Rebate(£14,050)
Net Outlay£7,550

### Charge to Profit and Loss Account

Depreciation:6 x £700=£4,200
Finance charges£5,100
Profit on sale(£1,750)
Net charge£7,550