Lease accounting: finance lease accounting: finance lessees: example 1: is this a finance lease?
The lease in Example 1 at BLM15505 is a finance lease as it is evident substantially all the risks and rewards incidental to ownership of the asset have been transferred.
In addition, the total rentals (other than the peppercorn rentals payable from year 6) are £62,000. The net present value of those rentals is more than 90% of the fair value of the asset (known to be £50,000). Whilst this is not conclusive evidence that the lease is a finance lease, it is supportive, and there is nothing to suggest that the lessor has anything other than a financier’s interest in the asset.
But note that, if SSAP21 is being applied, there is a rebuttable presumption that a lease is a finance lease where the net present value of the rentals is more than 90% of the fair value of the asset.
The rental terms (or repayment terms to give the transaction its true commercial meaning) are a crucial feature in this example. It is normally only possible to appreciate this by looking at all the terms of the agreement. For example there may be provisions specifying the implied interest rate. As in this example, there will also be provisions for terminal rentals and terminal rebates if the asset is sold. In the case of a finance lease the broad effect of such provisions is that the risks and rewards of ownership rest with the lessee - which is what makes the lease a finance lease, see BLM11200.