Finance Leasing Manual - FLM4.29

SSAP21 borderline between finance and operating leases: definition

SSAP 21 sets out a largely arithmetical borderline between finance leases and operating leases (for which debt is not shown on the balance sheet). It provides that:

'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 SSAP 21 and paragraph 64 onwards of the Notes on the Standard.)

The SSAP 21 borderline between finance leases and operating leases was open to exploitation after 1984, in order to secure once again the advantages of 'off balance sheet' finance for the lessee. Because there is an element of judgment in applying SSAP 21 it was possible for a lessor and lessee to reach opposite conclusions - the lessor could regard the deal as a finance lease while the lessee could treat it as an operating lease, creating a mismatch between the lessor's recognition of earnings and the lessee's recognition of expenses.