BLM20525 - Defining long funding leases: funding leases that are not long funding leases: short leases: leases with balloon rentals - meaning of residual value implicit in the lease

Where a lease with a term of more than 5 years but not more than 7 years includes a balloon rental it will not meet the definition of a short lease. (A balloon rental is a rental payable at or near the end of the lease term that is materially larger than previous rental payments.)

The residual value implicit in the lease is the value after the balloon has been accounted for and so a lease with a balloon does not meet the test for being a short lease because it fails to meet the conditions set out in BLM20515.

For example, a lessor buys an asset for £10,000 and leases it for 6 years at £1,500 a year with an additional balloon rental of £5,000 at the end of year 6. The total rentals are £14,000. The lessee also has the right to sell the asset (as agent for the lessor) at the end of the lease term and retain 99.9% of the proceeds.

The lessee will hope that the asset sells for at least £5,000. In this example it is reasonable to assume that the residual value implied in the lease is nil. However, the lease would not be a short lease because it would not meet conditions in BLM20515.