The total finance charge element in rentals is in practice the difference between the total rentals payable and the acquisition cost of the asset (which the lessee will sometimes have to estimate). The assumption made in determining how much of each rental is represented by finance charges is that the lessor's return (akin to interest) on its investment should be a constant percentage of the sums outstanding under the lease.
The profile of finance charges over the term of a finance lease where the rental payments in the primary period are constant will be similar to the interest element in repayments of an ordinary repayment mortgage loan. At first, most of the rentals will be the finance charge (interest in substance) and very little will be capital repayment. The finance charge element as a proportion of each rental will fall over the primary period until most of the rental is capital repayment and very little is finance charge.
Under SSAP21 there are several methods of calculating the
finance charge element in each rental. They vary in their degree of
sophistication and are described in more detail in the Guidance
Notes on SSAP21 prepared by the Accounting Standards Committee.
One simple method is the `rule of 78' or `sum of
digits'’. This derives from the era before computers and is
illustrated in the example in
BIM61055. Modern spreadsheets have built
in functions which make it easy to compute the figures.
