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

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.

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.