Finance Leasing Manual - FLM4.10

SSAP21: finance lessor's position from 1984

From 1984 the finance lessor's accounts show no physical asset in its balance sheet even though it owns the leased asset. Instead the lessor shows its financial investment in the lease (in substance, the 'loan' outstanding) as its asset. The loan is equal to the remaining capital instalments due under the lease. At the outset the 'loan' will generally be equal to the cost of the kit bought by the lessor.

For accountancy purposes the interest element in the rents is the gross trading earnings of the finance lessor. The capital element in the rentals is no longer earnings, so there is no need for a depreciation deduction. In practice, some finance lessors still keep to the old presentation and show gross rents (the 'interest' and 'capital' elements) reduced by depreciation equal to the capital element in the rentals payable in the year. But the arithmetical result is the same both before and after 1984: the true gross earnings for commercial accounting purposes is the 'interest'. Thus there has usually been little practical difference in the way net income has been recognised after 1984.

The lessor's main expense by far is the interest it has to pay on the money used to buy the asset it leases. This interest expense obviously declines as the 'capital' is repaid by the lessee. Accountants seek to match the interest payable by the lessor with the 'interest' earned on the capital each year.