BLM14010 - Lease accounting: finance lease accounting: finance lessors: finance income
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, and for lessors only under IFRS 16 and FRS 102 (2024 amendments).
A finance lessor's commercial income (the ‘gross earnings’) shown by its accounts is merely the ‘interest' on the ’loan' (as in the case of any lender).
FRS 102 (pre 2024 amendments) 20.19 sets out the method for the subsequent measurement of finance leases by the lessor:
“The recognition of finance income shall be based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease. Lease payments relating to the period, excluding costs for services, are applied against the gross investment in the lease to reduce both the principal and the unearned finance income. If there is an indication that the estimated unguaranteed residual value used in computing the lessor’s gross investment in the lease has changed significantly, the income allocation over the lease term is revised, and any reduction in respect of amounts accrued is recognised immediately in profit or loss”.
The same principles apply for finance lease accounting for lessors under FRS 105, FRS 102 (2024 amendments) and IFRS 16.
Example
The way the 'interest' recognition principles work for the lessor can be seen from the following highly simplified example where:
the lessor spends £10,000 on a piece of plant or machinery;
the plant or machinery is finance-leased for ten years;
the interest rate reflected in the lease (that is, charged to the lessee) is 11%;
the interest rate paid by the lessor is 10%.
The commercial profit of the lessor is its 1% turn on the debt outstanding each year less any other expenses (usually minor).
Year |
Interest Earnings at 11% |
Interest Payable at 10% |
Net Profit at 1% |
|---|---|---|---|
1 |
1,100 |
1000 |
100 |
2 |
1,035 |
937 |
98 |
3 |
962 |
868 |
94 |
4 |
880 |
792 |
88 |
5 |
790 |
709 |
81 |
6 |
690 |
617 |
73 |
7 |
579 |
516 |
63 |
8 |
456 |
405 |
51 |
9 |
320 |
282 |
38 |
10 |
168 |
148 |
20 |
Totals |
6,980 |
6,274 |
706 |
It may help to explain how the figures in the table are worked out. The total rentals payable by the lessee over the ten-year period of the lease are 16,980 (10,000 'capital' plus 6,980 'interest') – 1,698 each year on a straight-line basis. In Year 1 the lessor's interest earnings at 11% are based on the initial 10,000 'loan'. At the end of Year 1 the amount of the 'loan' outstanding has reduced to 9,402 (10,000 plus 1,100 less 1,698). This is the figure on which the 11% 'interest' is based for Year 2 (9,402 x 11% = 1,035). At the end of Year 2 the amount of the 'loan' outstanding has reduced to 8,738 (9,402 plus 1,034 less 1,698). This is the figure on which the 11% 'interest' is based for Year 3 (8,738 x 11% = 961). And so on.
The accounts will show the following figures:
Year |
Gross earnings |
Net Investment in lease at Start of year |
Reduction |
Net Investment in lease at End of year |
|---|---|---|---|---|
1 |
1,100 |
10,000 |
598 |
9,402 |
2 |
1,035 |
9,402 |
663 |
8,739 |
3 |
962 |
8,739 |
736 |
8,003 |
4 |
880 |
8,003 |
818 |
7,185 |
5 |
790 |
7,185 |
908 |
6,277 |
6 |
690 |
6,277 |
1,008 |
5,268 |
7 |
579 |
5,269 |
1,119 |
4,150 |
8 |
456 |
4,150 |
1,242 |
2,908 |
9 |
320 |
2,908 |
1,378 |
1,530 |
10 |
168 |
1,530 |
1,530 |
0 |
Total |
6,980 |
10,000 |
TThe lease rentals receivable, £1,698 a year, are not shown in the accounts as such, but are apportioned between the gross earnings (the ‘interest’ element) and the reduction in the net investment in the lease (the ’repayment’ element). For example:
Year 1 - 1,100 + 598 = 1,698
Year 2 - 1,035 + 663 = 1,698