Finance Leasing Manual - FLM10.42

Example 1: if lease is terminated early

Consider the possibility that the lessee no longer wants to use the leased asset at the end of the fourth year. The lessee terminates the lease. It is then required to be sold to an unconnected party. Following Example 1 at FLM10.26 the sale takes place on the first day of year 5 for £42,000. At that point the lessee still 'owes' £11,600. Repayment of that will be the first charge on any sale proceeds.

The premature repayment will also cause the terms of the loan to be revisited. The rate of interest charged under a loan normally bears some relation to the period of the loan. Assuming this is a variable rate loan (normally tied to the London Inter-Bank Official Rate, LIBOR), shorter loans tend to bear marginally higher rates. The premature termination may therefore increase the rate. The repayment might cost (say) £12,000 (including £400 extra interest).

The accounting entries are set out at FLM10.43.