Finance Leasing Manual - FLM13.21

Example: accounting treatment 2

The second accounting treatment regards the transaction purely as a refinancing exercise. The asset is not treated as if it had been sold and the profit on sale is not taken. The asset stays in the vendor's balance sheet at its book value and the sale proceeds is shown as a creditor. The accounting entries are:

Dr bank a/c £30,000
-------
Cr lease creditor a/c £30,000
-------

At the end of Year 5 the asset is in the balance sheet at its written down value of £25,000 (cost £50,000 less depreciation £25,000)

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

Depreciation of asset as before
(10 % x original cost of £50,000) = £5,000


Tax consequences

If accounting treatment 2 is used, so that the sale is not recognised and is treated as refinancing, the tax consequences are as follows.

• Under the new finance lease, the capital repayment element in the rentals total £30,000 and this is payable over five years (Years 6 to 10 inclusive). The asset will be worth nothing at the end of ten years and so the full amount of these rentals has to be written off over this period. But, because the asset has stayed in the balance sheet at its existing written down value of £25,000, the actual depreciation charge will only write off £25,000 by the end of year ten - a shortfall of £5,000. To find the allowable revenue rental deduction each year you use the actual rate of write off in the accounts as a guide. That is, multiply the total capital repayable (£30,000) by:

the actual depreciation each year (£5,000)

-------------------------------------------------

the total amount of actual depreciation (£25,000)

= 1/5th or 20 %.

• In this example 20% of the total capital element in the rentals (£30,000) is allowable for tax purposes each year, namely £6,000.

• Depreciation of £5,000 is actually charged in arriving at the commercial profits each year. So a further £1,000 a year must be deducted in the tax computation.

• There has actually been a sale and so there may be a capital allowances balancing event and also a gain chargeable to capital gains tax.

If the sale and lease-back was for £20,000 rather than £30,000, the accounting entries under method 2 would be unaffected. The charge to P&L would be £5,000 per annum. But this would have to be adjusted for tax purposes to add back the amount of the depreciation that represents the capital loss on sale of the asset (£5,000), the amount disallowed being £1,000 for each of the 5 years of the finance lease.