Finance Lease

NickyW

Has anyone got a good definition of a finance lease and how you account for it?
Also if you buy something on HP is this a finance lease? Would you account for depreciation in the same way as if you had bought the asset with cash?

Richard

A finance lease tends to be long term borrowing. The risks and rewards of ownership are therefore transferred to the lessee, (the company that is going to be using the asset), which means that it will be recognised on the balance sheet as an asset and will be depreciated in the usual way.

It will also show as a liability on the balance sheet, and as payments are made, the liability will reduce. The payments are split between repayment of the borrowing, and the finance charge (interest). The interest is recognised as an expense on the P&L account.

lv9783

can anyone explain hire purchase and lease... and how you deal with them in the financial statements

NickyW

Thanks for this.
Can you explain one other thing?
If the asset is bought on a finance lease, it doesn't become the property of the lesee(?) until the last payment is made. However it shows on their balance sheet as an asset from day 1 - is this right?

peugeot

Yes you are right - the lessee may have an 'option to purchase' for a bargain price at the end of the lease at which time title will pass.

The reason the asset is recorded as an asset in the balance sheet is because the financial statements should report the 'substance' (i.e. the commercial reality) of the transaction as opposed to its 'legal form'. In substance, the company 'owns' the asset so the financial statements need to recognise this.

Kind regards
Steve

NickyW

Thanks for this!!

lv9783

sorry im struggling with this subject as only realised this evening we need to know it.

could someone explain lease and hire purchase to me?
:huh:

peugeot

Hi,

As Richard mentioned above, a finance lease is a lease where essentially all the 'risks and rewards' of ownership pass to the lessee. The lessor will still legally own the asset, but it is recorded in the balance sheet (with a corresponding creditor) at the asset's value (usually in the agreement). Hire purchase contracts are often referred to as 'finance' leases.

You debit fixed assets and credit liabilities for the initial recording of the asset's price. You depreciate the asset over the shorter of the expected useful life of the asset or the lease term. Where payments to the lessor are concerned, you credit cash at bank and debit the liability account (with the capital amount only), the interest element of the payment is charged as a finance cost to the profit and loss account.

An operating lease is a lease which is NOT a finance lease. This is because the lessor retains all the risks and rewards. In practical terms, the lessee will use the asset but the lessor will be responsible for repairs and maintenance. The 'rewards' are the rents received from the lessor. Payments to the lessor are simply charged to the profit and loss account.

In contrast therefore, with a 'finance' lease, the lessee will be responsible for the risks (maintenance, general repairs, obsolescence etc) and the 'rewards' the revenue the asset generates for the business.

I wrote an article on IAS 17 (the international equivalent to SSAP 21 -the provisions in IAS 17 are the same as SSAP 21) which helps understand this subject better. It can be found here.

lv9783

Thank you so much you are a life saver and a mega star :thumbup1:

visha

This accounting standard is not now examined at AAT Intermediate level.

So don't worry about it for tomorrow

lv9783

I hope not...I get concerned especially after ecr, what they may put in lol
:001_tt2:

peugeot

Don't get too paranoid!! If it's not examinable, the examiner cannot bring it in the paper so don't cause yourself any unnecessary work - I think you might have done enough!!:001_smile:

Good luck anyway.

Steve

lv9783

Cheers...its my birthday tomorrow so hopefully we'll get a nice easy one for a present lol:tongue_smilie:

peugeot

Well happy birthday for tomorrow and good luck as well - I hope it goes well for you (and all). I'm sure you'll be fine!!:thumbup1:

Regards
Steve

lv9783

thanks so much steve you are a big support on this forum

gill hakin

Thank you Steve, your post has just helped me accounts for my new asset finance lease which I was struggling with. Very useful.