Finance Leasing Manual - FLM2.03

Finance leasing: accountancy treatment

Accountants look at the reality and treat a finance lease as a loan by a lessor to a lessee which the lessee uses to buy the kit. The rental payments are analysed into their constituent economic parts - 'interest' and 'capital'.

Finance lessor

The finance lessor owns the asset but does not show it in its balance sheet. The lessor only shows the 'loan' it has made in its balance sheet. This is generally the cost of the leased asset.

The finance lessor's earnings are the 'interest' on the loan (the interest element in the rentals):

• the capital element in the rentals are loan repayments which go to the balance sheet to write down the debt;

• the 'interest' earnings are allocated to each year in proportion to the outstanding debt in each year.

Finance lessee

The finance lessee does not own the kit but shows it in its balance sheet as if it did (which is the economic substance if not, technically, the legal position). The finance lessee also shows the capital owed to the finance lessor as a debt.

In its profit and loss account the finance lessee

• charges the 'interest' (the interest element in the rentals) in the same way as any other loan interest

• does not charge the capital element in the rentals: they are treated as loan repayments which go to reduce the debt to the finance lessor included in the balance sheet

• instead charges depreciation on the asset.