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HMRC internal manual

# Lease accounting: finance lease accounting: finance lessors: 'interest' recognition example

The way the ‘interest’ recognition principles (see BLM14005 onwards) 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.

This example is over-simplified, particularly for SSAP21, because it takes no account of the detailed way in which the lessor’s net cash investment is calculated.