51²è¹Ý

This manual is being updated to reflect FRS 102 (2024 amendments). For guidance on the tax treatment of accounts prepared under IFRS 16 or the revised FRS 102, please refer to pages within the BLM50000 chapter.

This section is applicable to entities applying FRS 102 pre 2024 amendments or FRS 105.Ìý

See BLM17000 for lessee accounting under the on-balance sheet model under IFRS 16 and FRS 102 (2024 amendments).Ìý

TradCo enters into a lease with BankCo to hire an asset (which TradCo itself identified and had arranged for the finance leasing member of the banking group to buy at a cost of £50,000).Ìý The asset is estimated to have a useful life of 20 years.Ìý The terms of the lease are: 

• rent of £12,400 per annum payable in each year 1-5; 
• rent of £25 per annum payable in each year 6-25; 
• if the lessee wishes to terminate the lease then, net of any amounts outstanding on the financing arrangements, the lessee will receive a rebate of rentals equivalent to 97% of net sale proceeds.Ìý

Issues to consider from an accountancy point of view are: 

• whether this is a finance lease the apportionment of the rentals between 'interest' and 'capital' elements allocating the rentals between the 'interest element' and ‘capital element’ over the lease period 

Is this a finance lease? 

This lease is a finance lease as it is evident that substantially all the risks and rewards incidental to ownership of the asset have been transferred.Ìý

The rental terms (or repayment terms to give the transaction its true commercial meaning) are a crucial feature in this example.Ìý It is normally only possible to appreciate this by looking at all the terms of the agreement.Ìý For example, there may be provisions specifying the implied interest rate.Ìý As in this example, there will also be provisions for terminal rentals and terminal rebates if the asset is sold.Ìý In the case of a finance lease the broad effect of such provisions is that the risks and rewards of ownership rest with the lessee – which is what makes the lease a finance lease, see BLM11200.Ìý

Apportioning the rentals 

Having established that the lease in the example is a finance lease, it must be accounted for in that way under FRS 102 (pre 2024 amendments) or FRS 105.Ìý As described at BLM13000 onwards it is necessary to split the total rentals into two components, namely: 

• an amount representing the 'capital' value of the lessee's rights in the asset, which is treated as an asset and depreciated as a fixed asset; and 
• the finance charges (the amounts that equate to interest payable under the 'loan').Ìý

In this example the secondary lease period rentals can be ignored.Ìý These are no more than a handling charge to compensate the lessor for any costs of 'holding' the asset.Ìý Whether or not rentals payable in a secondary period should be ignored will depend on the facts of each case. Ignoring the rentals payable in the secondary period the following calculation is made: 

Lease rentals (£12,400 x 5 years) £62,000

Amount capitalised (treated as an asset in the balance sheet) £50,000

Finance charges £12,000

Allocating the interest element and the finance element 

Using the effective interest method an effective interest rate of 7.63% can be calculated and this results in a split between the capital element and interest element as shown in the table below.Ìý

Year	Rent (£)	Interest element (£)	= capital element (£)
1	12,400	3,814	8,586
2	12,400	3,159	9,241
3	12,400	2,454	9,946
4	12,400	1,695	10,705
5	12,400	878	11,522

The allocation of the rentals can then be translated into accounts format:

Balance sheet	£ at start	£ year 1	£ year 2
Assets	-	-	-
Leased asset	50,000	50,000	50,000
Depreciation	-	2,500	5,000
Balance	50,000	47,500	45,000
Liabilities	-	-	-
Lease creditor	-	50,000	41,414
Repayment	-	8,586	9,241
Net	-	41,414	32,173

Profit and loss account	£ at start	£ year 1	£ year 2
Depreciation	-	2,500	2,500
Finance charge	-	3,184	3,159

Value of assets and liabilities in the balance sheet 

A point of interest worth noting from the accounting entries  is that the amount of the lease creditor is less than the book value of the asset.  This is what would be expected, particularly where the loan implicit in the lease is being repaid over a relatively short period.  It also underlines the point that, from the lessor's standpoint, this sort of structure gives the provider of finance security beyond that provided by the financial standing of the lessee.Ìý

If the value of the liability exceeds that of the asset (or the asset exceeds that of the liability, but only just so that it does not offer much comfort to the creditor bank) for a typical finance lease there may be several possible reasons, some wholly unrelated to tax.Ìý For example, it is very often the case that if the lessee looks a good credit risk the lessor will be indifferent to whether the asset provides adequate security.Ìý

But, because the tax treatment follows the accounting, two of these possible reasons have tax implications:.Ìý

• The asset is being depreciated too quickly.Ìý
• The allocation of interest is suspect (if the amount allocated to interest is 'too high', this depresses the amount allocated to loan repayments thus increasing the balance outstanding).Ìý

The effect in either case is likely to be to accelerate the deductions for lease rentals (though neither will affect the sums ultimately deductible) and it may be appropriate to consider, together with your Advisory Accountant, whether (and if so how) the treatment in the accounts should be questioned.Ìý