Lease accounting: finance lease accounting: finance lessees: profit and loss account
Under the lease the lessee pays rents. For a ‘classic’ finance lease the effect of paying rent is that the lessee repays the lessor for both its investment in the asset, and pays interest. As for a loan, the interest element is written off over the ‘loan’ period, which will normally correspond to the primary lease period. In other words, the rents that represent ‘interest’ are not written off in the same way, nor over the same period of time, as rents that represent the repayment of the investment. Thus, in order to give effect to the accounting treatment it is necessary to apportion rents between these two elements.
The rentals payable by the lessee are split into two elements:
- one is a ‘capital’ element repaying the ‘loan’ (reducing the liability in the balance sheet)
- the other is a ‘finance charge’ or ‘interest’ element (which is debited to the lessee’s profit and loss account).
The finance lease will therefore be reflected in the lessee’s profit and loss account through a depreciation charge (BLM15015) and a finance charge.
Note that the depreciation charge is not the same as the capital element of the rentals on a period by period basis. However, over the term of the lease the total of the capital elements will in principle be equal to the sum of the depreciation charges as both are based on the cost of the asset at the beginning of the lease.