BLM20330 - Defining long funding leases: plant or machinery leased with other assets: derived lease examples

Example 1

In example 1 in BLM20320 a factory is leased for 35 years with production plant with a useful economic life of 20 years. The rentals might be £20,000 a month.

If the plant had a value of £1million and was leased for 20 years it might be that a rental £8,000 a month would be necessary to amortise the £1 million to nil over the 20 years and give the lessor an appropriate interest return. In other words, if the plant had been leased under its own full payout finance lease the monthly rentals might have been £8,000 a month. (Remember that it should be assumed the rentals are payable in equal instalments unless it is reasonable to draw a different conclusion.)

On that basis, the rentals attributable to the factory would be £12,000 a month for the first 20 years, rising to £20,000 a month thereafter. This may look a little odd, but that reflects the assumption made in the example that the rent under the mixed lease would be constant. In practice this is unlikely, as the lessor will want to get its investment in the plant or machinery back over the 20 years of its useful life and rent the factory at rising rental over the 35 years.

Example 2

The facts are the same as in Example 1 except that the rentals under the mixed lease start at £6,000 a month for the first year and rise at £8,000 a month in year 2 and £10,000 a month in year 3, and so on to whatever level is necessary to give the lessor a commercial return on its investment over the 35 years.

The rentals for the plant would have to be limited to £6,000 a month in the first year, rising to £8,000 a month in year 2 and to slightly over £8,000 a month thereafter (to compensate for the low rentals in year 1).