Accounting Treatment of an HP Agreement

Dawny

My client is leasing a car through his company. The agreement is a 36 month agreement with the option to purchase the car at the end for a figure roughly the market value, so I believe this is classed as an operating lease.

Could someone please confirm the accounting treatment to this. Should the rental cost (capital and interest) be debited to the Profit and Loss each month, and not capitalised in the balance sheet. Alternatively, should the loan be reflected in the Balance Sheet, to be reduced with each payment, and only the interest debited to the Profit and Loss.

Thank you.

stevef

An agreement with an option to purchase at the end of the agreement at a substantially lower figure than fair value at the start of the agreement is a finance lease. HP agreements are nearly always finance leases as they allow the lessee to purchase at an estimated market value at the end of the agreement which is lower than fair value at the start.

So you will need to record the car as an asset in the balance sheet and set up a liability to repay the principle. Each year you charge the interest to profit and loss and reduce the liability to repay by the principle. The split between the interest and principle has to be calculated using an actuarial method (so that interest reduces each year and principle increases (as I am a bit of a dinosaur, I use sum of digits as I understand the calculation).

You will also need to depreciate the asset over the period of the agreement.