BLM14040 - Lease accounting: finance lease accounting: finance lessors: 'interest' recognition example

The way the ‘interest’ recognition principles (see BLM14005 onwards) work for the lessor can be seen from the following highly simplified example where:

• the lessor spends £10,000 on a piece of plant or machinery;
• the plant or machinery is finance-leased for ten years;
• the interest rate reflected in the lease (that is, charged to the lessee) is 11%;
• the interest rate paid by the lessor is 10%.

The commercial profit of the lessor is its 1% turn on the debt outstanding each year less any other expenses (usually minor).

Year	Interest Earnings at 11%	Interest Payable at 10%	Net Profit at 1%
1	1,100	1000	100
2	1,035	937	98
3	962	868	94
4	880	792	88
5	790	709	81
6	690	617	73
7	579	516	63
8	456	405	51
9	320	282	38
10	168	148	20
Totals	6,980	6,274	706

It may help to explain how the figures in the table are worked out. The total rentals payable by the lessee over the ten year period of the lease are 16,980 (10,000 ‘capital’ plus 6,980 ‘interest’) – 1,698 each year on a straight-line basis. In Year 1 the lessor’s interest earnings at 11% are based on the initial 10,000 ‘loan’. At the end of Year 1 the amount of the ‘loan’ outstanding has reduced to 9,402 (10,000 plus 1,100 less 1,698). This is the figure on which the 11% ‘interest’ is based for Year 2 (9,402 x 11% = 1,035). At the end of Year 2 the amount of the ‘loan’ outstanding has reduced to 8,738 (9,402 plus 1,034 less 1,698). This is the figure on which the 11% ‘interest’ is based for Year 3 (8,738 x 11% = 961). And so on.