Hi, can someone provide me with some guidance on accounting for this Finance Lease query? I have two questions.
Question 1
We acquire an asset on a Finance Lease. We know the true capital cost of the asset from the actual supplier and so know the cost of finance based on the total commitment to the Finance House.
Therefore I believe the starting accounting entries to be:
1(a). Fixed Asset addition at purchase cost (this is excluding the cost of finance)
1(b). Finance Lease Liability at purchase cost (this is excluding the cost of finance)
Then each month as the payments are made to the Finance House:
2(a). Depreciation charge on asset based on depreciation policy.
2(b). Reduction in Finance Lease liability based on capital element only of monthly payment to finance house.
2(c). Interest charge through the P&L for interest element of payment made to Finance House.
Is this the correct method of accounting for this Finance Lease?
Question 2
The intention will be to take up the option to purchase this asset at the end of the minimum term of the lease. In order to complete that process the Finance House require a further payment equivalent to 3 months of the regular rental payment.
How do we account for this? Should this impact the original Fixed Asset addition value? Because there is no commitment to purchase this asset when the Finance Lease first commences I don't think we should include this at the start of the agreement?
Could someone provide me with a little guidance on this please?
Replies (11)
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Question 1
Yes - although you don't mention how you split the repayments between interest and capital.
Question 2
The balloon payment is just part of your calculation of the interest rate implicit in the lease, which in turn will be your basis for splitting the repayments between interest and capital.
I would be reluctant to use the straight line method unless the numbers were immaterial. With Excel it takes no time at all to do it all properly.
Yes I think you include the balloon payment in your calculations from Day 1.
All this assumes that it is a finance lease of course.
Are you sure this is a finance lease? A finance lease agreement should not contain any option to purchase the asset at the end of the lease. Finance lease assets are in practice commonly purchased/retained at the end of the lease (and there is often an informal agrement at the outset that this option will be available), but strictly this should be (and normally is) dealt with by way of a separate agreement.
Yes - the key words being "The agreement doesn't contain any option to purchase at the end"
No, I don't agree with John. It's not a balloon payment, it's a payment - under a seprate agreement - to effectively take ownership of the asset. So I wouldn't do anything with it until it has actually been incurred - who knows, the trader may decide that at the end of the lease the asset is worthless and choose not to take up the 'option' and simply hand the asset back.
In what way?
In that my post revealed post number 6. There is a problem with the website, but the developers are nowhere to be found.