Finance Leasing Manual - FLM10.09

Lessee's profit and loss account

Under the lease the lessee pays rents. For a 'classic' finance lease the effect of paying rent is that the lessee repays the lessor both his investment, and pays interest. As for a loan, the interest element is written off over the 'loan' period, which will normally correspond to the primary lease period. In other words, the rents that represent 'interest' are not written off in the same way, nor over the same period of time, as rents that represent the repayment of the investment. Thus, in order to give effect to the accounting treatment it is necessary to apportion rents between these two elements.

The rentals payable by the lessee are split into two streams,

• one a 'capital' element repaying the 'loan' (reducing the liability in the balance sheet) and

• the other a finance charge or 'interest' element (which is debited to the lessee's profit and loss account).

The finance lease will therefore be reflected in the lessee's profit and loss account through a depreciation charge and a finance charge. Over the term of the lease the total rentals payable will in principle be equal to the sum of the depreciation and finance charges.