Finance Leasing Manual - FLM1.11

When is a lease a finance lease?

Accountants define a finance lease like this:

'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.'

Paragraph 15 of Statement of Standard Accounting Practice 21 and paragraph 64 onwards of the Notes on the Standard.)

It identifies who has the bulk of the equity interest in the leased asset - the lessor or the lessee. 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 at least 90% of the cost of the asset (the 'loan') to the lessor plus a commercial rate of interest.

The 'fair value' of the leased asset is, at its simplest, its cost. But cases may not always be simple and paragraph 25 of SSAP 21 defines 'fair value' to mean the arm's length sale price of the leased asset when the lease is granted.

SSAP 21 and the accompanying Notes are well worth studying in order to fully understand the nature of finance leasing and the accounting mechanics.