Finance Leasing Manual - FLM13.16

Example: accounting treatment 1

The first accounting method treats the asset as sold and the profit amortised over the lease term, and then accounts for the finance lease as a separate transaction. The accounting entries are:

Cr asset a/c £25,000
Cr suspense a/c (profit on sale) 5,000
-------
Dr bank a/c 30,000
Cr lease creditor a/c 30,000
-------
Dr leased asset a/c £30,000
-------

Annual entries in profit and loss a/c: Years 6 - 10

Credit 1/5th x profit on sale of asset
(£30,000 - £25,000) (£1,000)

Debit depreciation of leased asset £6,000

In other words, the trader is treated for accountancy purposes as if he had first acquired the asset under a finance lease at the end of year 5 for £30,000 and that cost is written off over the remaining five years of useful life; that is, there is a depreciation charge of £6,000 a year for five years.

Tax consequences

The tax consequences if accounting treatment 1 is used and the asset is treated as sold and profit written off are:

• the profit on sale (£1,000 pa) is a capital profit - as it is included in the commercial profit, it must be deducted to arrive at the taxable profit;

• there may be a capital allowances balancing event and also a gain subject to a capital gains tax charge.

If the asset had been sold and lease-backed for £20,000, there would be a loss on sale of £5,000. The net accounting entry would still have been £5,000 each year (rent/depreciation £4,000 plus loss on sale of £1,000). But the loss on sale should be excluded for tax purposes, leaving only the annual rent (described as depreciation) of £4,000 per annum (£20,000/5 years) deductible.