BLM11200 – Lease accounting: lease classification: defining finance leases under UK GAAP

Finance leases are defined in similar way under both UK GAAP and IFRS (see BLM11205).

UK GAAP defines a finance lease in the following terms (paragraph 15, SSAP 21):

“A finance lease is a lease that transfers substantially all the risks and rewards of ownership of an asset to the lessee. It should be presumed that such a transfer of risks and rewards occurs if at the inception of the 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. The present value should be calculated by using the interest rate implicit in the lease (as defined in paragraph 24). If the fair value of the asset is not determinable, an estimate thereof should be used.”

In general terms, the definition identifies whether or not the lessor has the bulk of the equity interest in the leased asset. In particular, what this is saying is that it should be presumed that a lease is a finance lease where the payments by the lessee are certain (subject to the credit risk) to repay substantially all of the cost of the asset (the 'loan') to the lessor plus a commercial rate of interest.

Note that ‘substantially all’ means ‘normally 90% or more’ and the definition is based on risks and rewards. It is particularly important to note that the figure of 90% is only indicative – that is, the presumption in the definition is rebuttable.

Therefore, where a lease meets the conditions in paragraph 15 of SSAP 21, the presumption that it should be classified as a finance lease may in exceptional circumstances be rebutted if it can be clearly demonstrated that the lease in question does not transfer substantially all the risks and rewards of ownership (other than legal title) to the lessee. Correspondingly, the presumption that a lease which fails to meet the conditions in paragraph 15 is not a finance lease may in exceptional circumstances be rebutted, see paragraph 16 of SSAP 21.

For example, exceptionally, the rentals can pay all the fair value of the leased asset and GAAP will still regard the lease as an operating lease if the lease does not transfer substantially all the rewards of ownership to the lessee. Equally, it might be possible for the rentals to pay less than 90% of the fair value of the asset and for the lease to be regarded as a finance lease if the lease does transfer substantially all the rewards of ownership to the lessee.

Any question of whether a lease is, or is not, a finance lease must be referred to your local advisory accountants.