Example
Assume that a ship costs £50m and has a useful life of
30 years. A ship operator does not want to buy the ship but wants
to use it for at least 10 years. It therefore approaches a lessor
bank and it is agreed that after 10 years there is a high
probability that the value of the ship will be at least £35m.
The lessor bank approaches the arrangement by assuming that
it will be able to sell the asset for at least £35m at the end
of the lease term. On that basis the bank can proceed if, over the
10 years of the lease, it will receive £15m plus sufficient to
cover its cost of borrowing and provide it with a profit.
Assume that in this case the lessor needs to charge 6%
interest to the lessee. In that case the lessor needs to charge a
rental of £4.14 m a year and a very simple analysis of the
lease rentals might look like:
| Year | Annual Rent | Interest | Capital Element | Loan balance |
| 1 | 4.14 | 3.00 | 1.14 | 48.86 |
| 2 | 4.14 | 2.93 | 1.21 | 47.66 |
| 3 | 4.14 | 2.86 | 1.28 | 46.38 |
| 4 | 4.14 | 2.78 | 1.36 | 45.02 |
| 5 | 4.14 | 2.70 | 1.44 | 43.58 |
| 6 | 4.14 | 2.62 | 1.52 | 42.06 |
| 7 | 4.14 | 2.52 | 1.61 | 40.45 |
| 8 | 4.14 | 2.43 | 1.71 | 38.74 |
| 9 | 4.14 | 2.32 | 1.81 | 36.92 |
| 10 | 4.14 | 2.22 | 1.92 | 35.00 |
| Total |
| 26.38 |
|
|
(An actual analysis would be very much more complex than
this.)
On the simple facts outlined here, the lease is clearly an
operating lease and the accounting will follow the legal form of
the contract. The split into ‘interest’ and
‘capital’ is performed purely for the purpose of
calculating the appropriate rentals. The tax consequences are
discussed at
BLM31215.
The lessor’s profit will increase if it is able to sell
the asset for more than £35m and will fall, or even be wiped
out, if the market moves adversely and the ship’s value falls
further than expected to below £35m.
Clearly this method cannot be used if the asset is leased out
on many short leases where the rentals are set by reference to
market rates, but it is perfectly appropriate where the operating
lease is a long one and is designed to function in much the same
way as a loan (albeit a loan where the lessor is taking some
residual value risk).
