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HMRC internal manual

Business Leasing Manual

Lease accounting: finance lease accounting: finance lessees: methods for apportioning rent

Finance charges incurred on the obligation to pay future rentals are normally written off over the primary lease period - as in the case of a loan. This may differ from the period over which the asset is depreciated, see BLM15015.

SSAP 21 (paragraph 35) provides that

“…the total finance charge under a finance lease should be allocated to accounting periods during the lease term so as to produce a constant periodic rate of charge on the remaining balance of the obligation for each accounting period, or a reasonable approximation thereto.”

For those UK GAAP entities applying FRS102, Section 20 paragraph 11 says

“…the lessee shall allocate the finance charge to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability.” 

IAS 17 (paragraph 25) is very similar:

“…the finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability.”

The method by which this is done under SSAP21 is set out in paragraph 20 of the Guidance Notes that accompany SSAP 21 which state that

“The capitalisation of finance leases is now illustrated by means of numerical examples. Three methods of writing off finance charges are shown:

  1. the actuarial method;
  2.  the ‘Rule of 78’ (or ‘Sum of the Digits’) method, and
  3. the straight-line method.”

Of the above three methods, the actuarial method gives the most accurate result. All three methods are allowed as long as they give a result that does not differ materially (for accountancy purposes) from the actuarial result. See also BLM15630.

Neither FRS102 nor IAS 17 provide guidance on methods that may be used to allocate the finance charge. They simply state that the finance charge should be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. IAS 17 does however allow finance lessees to use some form of approximation to allocate the finance charge to periods during the lease term. FRS102 does not refer to using a form of approximation.

The Guidance Notes that accompany SSAP 21 explain how the three methods of writing off finance charges operate. The detail is not repeated here. The object of referring to the standards is to draw attention to the fact that there are three different methods and that this is not a wholly mechanical arithmetical process: judgements have to be made. If difficulties arise in practice you should seek accountancy advice.