BLM15605 - Lease accounting: finance lease accounting: finance lessees: example 2: back-loaded rental structure
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).
TradCo enters into a lease with BankCo under which it hires an asset (which TradCo itself had identified and had arranged for the bank to buy at cost £50,000). The asset is estimated to have a useful life of 20 years. The terms of the lease are that:
rent of £1,000 per annum is payable in each year 1-3;
rent of £34,000 per annum is payable in each year 4-5;
rent of £50 per annum is payable in each year 6-25; and
if the lessee wishes to terminate the lease, then, net of any amounts outstanding on the financing arrangements, the lessee will receive a rebate of rentals equivalent to 97% of net sale proceeds.
The facts are as in Example 1(starting at BLM15500),except that the 'profile' of the rents in the primary lease period is different and, because the amount borrowed is effectively outstanding for a longer period, this is reflected in larger overall repayments or rent.
Issues to consider from an accountancy point of view, as with Example 1 (starting at BLM15500), are:
the apportionment of the rentals between 'interest' and 'capital' elements, allocating the 'interest element' of the rentals over the lease period, using the effective interest method
Apportioning the rentals
As with the lease in Example 1 (see BLM15500) the process for apportioning the rentals between the income and capital elements is:
Lease rentals (£1,000 x 3 years) |
£ 3,000 |
Lease rentals (£34,000 x 2 years) |
£68,000 |
Lease rentals (total) |
£71,000 |
Amount capitalised |
£50,000 |
Finance charges |
£21,000 |
The finance charge is higher than Example 1 because the capital element remains outstanding longer and because the risk to the lessor is greater because the asset will be worth less than the capital outstanding throughout the life of the lease.
The accounting entries
Using the effective interest method for the lease in the example described at BLM15605 onwards, an effective interest of 8.35% can be calculated and this results in interest as shown in the table below:
Year |
Balance b/f (£) |
Interest Charge (£) |
Rent Paid (£) |
Balance c/f (£) |
|---|---|---|---|---|
1 |
50,000 |
4,175 |
1,000 |
53,175 |
2 |
53,175 |
4,440 |
1,000 |
56,615 |
3 |
56,615 |
4,727 |
1,000 |
60,342 |
4 |
60,342 |
5,038 |
34,000 |
31,380 |
5 |
31,380 |
2,620 |
34,000 |
nil |
In Example 2, the accounting entries would then be:
Balance Sheet at End |
Year 1 (£) |
Year 2 (£) |
Year 3 (£) |
Year 4 (£) |
Year 5 (£) |
|---|---|---|---|---|---|
Assets |
|||||
Leased Asset |
50,000 |
50,000 |
50,000 |
50,000 |
50,000 |
Depreciation |
(2,500) |
(5,000) |
(7,500) |
(10,000) |
(12,500) |
Net |
47,500 |
45,000 |
42,500 |
40,000 |
37,500 |
Liabilities |
|||||
Lease creditor |
50,000 |
53,175 |
56,615 |
60,342 |
31,380 |
Accrual/Repayment |
3,175 |
3,440 |
3,727 |
(28,962) |
(31,380) |
Net |
53,175 |
56,615 |
60,342 |
31,380 |
Nil |
Profit and Loss A/c |
|||||
Depreciation |
2,500 |
2,500 |
2,500 |
2,500 |
2,500 |
Finance Charges |
4,175 |
4,440 |
4,727 |
5,038 |
2,620 |