Accounting for a finance lease

Accounting for a finance lease

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We have taken on a new client that is a small motor garage.  They have only been established a few years and at the outset they took out hire agreements for the bulk of the necessary equipment.

I am of the opinion that the agreements qualify as finance leases per SSAP21, however the previous accountant has not entered the assets into the Balance Sheet and instead treated each payment as a cost in that year under Equipment Rental for the prior two periods Financial Statements.

The agreements end shortly and after a balloon payment they will become property of my client so my question is this:  What is the best way of correcting the Financial Statements for this period (i.e the period prior to when the agreements will end) and showing a suitably depreciated assets?  Or, am I better simply continuing the historic treatment until the payments cease?  This pains me simply because, although it will have depreciated fully, I would have preferred to show these assets in the register.

Replies (15)

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By johngroganjga
24th Oct 2014 15:47

I would let the current accounting treatment run its course.

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By RFL H
24th Oct 2014 15:53

I agree and

I would treat the balloon payments as your fixed asset costs going forward.

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By TerryD
24th Oct 2014 17:03

I agree with RFL H. Or stop the payments being shown as rentals from the beginning of the year you're doing and capitalise at that date. Certainly no point spending time and effort unwinding what is really a fait accompli.

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By Rowberry
24th Oct 2014 17:51

Thank you, I appreciate the responses.  Further probing suggests that the final 'balloon' payments will simply be the sum of another months rental and so not worth capitalizing by themselves. 

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By coolmanwithbeard
28th Oct 2014 12:26

From an accounting point of view.....

I would agree that is a pragmatic approach but what has happened to the tax relief?

If the goods had been capitalised on day one they would have been eligible for AIA. Were the lease payments claimed as expenses within appropriate limits in year one?. If AIA was not claimed in full (unlikely as treated as a lease rental) the subsequent capital allowances would be at the normal rate based on the balance brought forward. It is unlikely that any Capital Allowances or AIA are shown on the return for these goods.

I know tax follows GAAP but GAAP has not been correctly applied here and so the tax does need looking at if the OP is not to risk over claiming in his first year on this job.

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Replying to SteveHa:
Portia profile image
By Portia Nina Levin
28th Oct 2014 12:33

No!

coolmanwithbeard wrote:

I would agree that is a pragmatic approach but what has happened to the tax relief?

If the goods had been capitalised on day one they would have been eligible for AIA. Were the lease payments claimed as expenses within appropriate limits in year one?. If AIA was not claimed in full (unlikely as treated as a lease rental) the subsequent capital allowances would be at the normal rate based on the balance brought forward. It is unlikely that any Capital Allowances or AIA are shown on the return for these goods.

I know tax follows GAAP but GAAP has not been correctly applied here and so the tax does need looking at if the OP is not to risk over claiming in his first year on this job.

If this is genuinely a lease, rather than hire purchase, then there are no capital allowances for the lessor, irrespective of the accounting treatment. Capitalising the assets would simply have affected the timing of the relief for the lease payments.

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7om
By Tom 7000
28th Oct 2014 12:41

what i would do

is look at the VAT treatment

No client  really cares about the accounts but if you get the VAT wrong you will have a grumpy client/ lawyer on your tale

 

Was there vat on the individual payments, if so it stinks of an operating lease anyway.

 

 

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Replying to Justin Bryant:
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By NDH
28th Oct 2014 14:33

VAt on finance lease

Tom 7000 wrote:

is look at the VAT treatment

No client  really cares about the accounts but if you get the VAT wrong you will have a grumpy client/ lawyer on your tale

 

Was there vat on the individual payments, if so it stinks of an operating lease anyway.

 

 

 

Finance leases can have VAT on the individual payments also so just because VAT is present doesn't mean it's an operating lease.

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Portia profile image
By Portia Nina Levin
28th Oct 2014 12:52

Oh look

A full normal idiocy service has been resumed!

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By coolmanwithbeard
28th Oct 2014 13:00

YES


We are talking about the lessee here; CA23310 advises about the situation with normal leases but also indicates that with a genuine finance lease lessees can receive the benefit of ownership as with HP. It words it if the contract is treated as a finance lease in accordance with GAAP.

 

This would appear to be the opinion of the OP that under GAAP it was a genuine finance lease.

 

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Portia profile image
By Portia Nina Levin
28th Oct 2014 13:10

No!

CA23310 deals only with hire purchase contracts, and so-called lease purchase agreements.

If it is genuinely a finance lease (no option to purchase), and not a long-funding lease, then the treatment is to deduct the depreciation and the part of the lease payments that is treated as interest. That has the effect of giving relief for the total lease payments over the life of the lease.

Rather than reading one little section of the CAs manual, you need to read the entire business leasing manual. See http://www.hmrc.gov.uk/manuals/blmmanual/index.htm

And http://www.hmrc.gov.uk/manuals/blmmanual/BLM32210.htm in particular.

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By coolmanwithbeard
28th Oct 2014 14:26

Still disagree Portia in this context

SSAP 21 has two definitions Operating Lease and Finance Lease. On the basis of what the OP has said in his initial post and subsequently he is happy this is the latter under the terms of SSAP21.

BLM39010 further breaks down the distinction (a did my earlier quote from CA manual). The OP poster has made it clear that this is a finance lease and that at the end the goods will become the property of his client business. The "balloon" payment he describes is equal to one months payment, was set at the outset of the agreement and so bears no relation to market value.

Although I admit I don't have the figures to check in my experience these leases take on the Darngavil concept in that in reality there is interest and capital and no extra element for hire. As such, for tax purposes, they adopt the character of an HP agreement as capital repayments are not allowable for tax purposes.

As such the correct approach for tax purposes is that laid out in CA23310 and capital allowances may be appropriate. CA23310 also removes the right for lessors to claim CA.

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Portia profile image
By Portia Nina Levin
28th Oct 2014 14:38

BLM39010

You missed the bit that potentially makes a lease with a balloon payment ineligible for capital allowances:

"A lease contract with an option for the lessee to acquire the asset falls within CAA01/S67 if the option to acquire the asset is below the expected market value of the asset at the date the option is exercised."

Te he OP has not given us enough information to determine whether CAs are available. If it is a lease, that is not a long-funding lease and does not fall within section 67, then capital allowances are not available, irrespective of what the accounting treatment might be.

I am rather suspicious that the OP has not even got the accounting treatment correct, incidentally.

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By coolmanwithbeard
28th Oct 2014 15:29

I think

we are in agreement - and there are some key bits of information missing. BUT in common with other clients I have we appear to have a fairly short term period (3 years?) and if the market value isn't higher than 1 months payment I'd be very surprised (and the new owner would be very disappointed!). If there is a likelihood that is does fall under S67 then my original point stands that the tax position is an issue the OP needs to consider alongside whatever accounting treatment is selected.

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By Rowberry
29th Oct 2014 13:41

Just seen these

It is true that key pieces of information are missing, but they are missing for me also.  The former accountant has not furnished me with copies of the full, original agreements and the client claims to not have them either.  They have been requested from the lessor but who knows when they will turn up.

 

The facts as I understand are:  3 year agreement, VAT is being paid on each 'rental', one final payment should transfer the assets into ownership.  This has only been confirmed at this stage by the Director and the Sage records provided.

I don't even have a breakdown of the actual assets purchased to ascertain any kind of market value argument, the details I have are 'MOT Equipment".

The tax treatment so far has been claiming the net sum of the rental payments against Corporation Tax.

 

I guess the bottom line is that in order to come to the correct conclusion I need the missing information but I am grateful for the input.

 

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