BLM15540 - Lease accounting: finance lease accounting: finance lessees: example 1: lease terminated early

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. 

See BLM17000 for lessee accounting under the on-balance sheet model under IFRS 16 and FRS 102 (2024 amendments). 

Consider the possibility that the lessee no longer wants to use the leased asset at the end of the fourth year.  The lessee terminates the lease.  It is then required to be sold to an unconnected party.  Assume that in this example the sale takes place on the first day of year 5 for £42,000.  At that point the lessee still 'owes' £11,522 (BLM15535).  Repayment of that will be the first charge on any sale proceeds. 

The premature repayment will also cause the terms of the loan to be revisited.  The rate of interest charged under a loan normally bears some relation to the period of the loan.  Assuming this is a variable rate loan , shorter loans tend to bear marginally higher rates.  The premature termination may therefore increase the rate.  The repayment might cost (say) £12,000 (including £478 extra interest). 

On the basis of this information the position will be that: 

  • the lessee sells the asset as agent for the lessor (the lease agreement normally provides for this); 

  • the lessor receives £42,000 sale proceeds, the first £12,000 of which is used to clear the loan; and  

  • under the terms of the lease the lessor pays the lessee a 'terminal rebate' (of rent) amounting to 97% of £30,000, that is £29,100. 

The entries in the lessee's accounts will be: 

Debit

Credit

Lease creditor

£11,522

Leased assets

£40,000

Interest on termination

£478

Bank

£29,100

Profit on sale

£1,100

£41,100

£41,100

The total cash outlaid by the lessee can be reconciled with the charges made to its profit and loss account over the period of the lease until it is terminated, as follows: 

Cash position 

£ 

Rentals paid for primary period: 4 x £12,400 = 

49,600 

Rebate received 

(29,100) 

Net outlay 

20,500 

Charge to Profit and Loss Account 

  

Depreciation: 4 x £2,500 = 

10,000 

Finance charges 

11,122 

plus extra on disposal 

478 

Profit on sale 

(1,100) 

Net charge 

20,500