BLM00235 – Introduction: Lease accounting: Finance lessee’s profit and loss account

In addition to showing in its balance sheet the leased asset and the liability to pay the ‘capital’ element in the rentals (accounted for in a similar way to a loan), the finance lessee also has to

• write off the 'interest' element in the rentals to its profit and loss account in a similar way to any interest on a loan (following the same principles as the lessor uses to recognise earnings); and
• depreciate the leased asset in the same way as for assets owned outright; thus, this is real depreciation, not an accounting fiction.

The timing of the deductions is important. For finance leases

• the interest is deducted by the finance lessee as it accrues and, in accordance with the proportionate principle, more interest will be due early on and less later; and
• the depreciation deduction depends on the life of the asset or the life of the lease if there is no certainty that the lessee will obtain ownership of the asset. Depreciation is calculated in accordance with the relevant accounting standard. For UK GAAP this is FRS15 'Tangible Fixed Assets'. For IFRS this is either IAS 16 ‘Property, plant and equipment’ or IAS 38 ‘Intangible assets’.

Further guidance on accounting for finance leases is at BLM13000.