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PCP Accounting Treatment

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I know this has been asked before but the answers always seem to be 50/50.

When on PCP, a £1,500 deposit, then 48 monthly payments of £150.49 (including interest) and a final balloon payment of £5,500 how does this get accounted for? Is it 48 payments on the P&L and if the balloon payment is taken up then it goes as an asset? Or does it go as an asset and hire purchase account on the balance sheet straight away?

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By Tax is always taxing
10th Aug 2021 08:05

Is the balloon payment optional or compulsory?

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Replying to Tax is always taxing:
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By Luke5
10th Aug 2021 08:07

Optional

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By Tax is always taxing
10th Aug 2021 08:22

In 4 years will the market value of the car be less than or more than the optional payment?

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Replying to Tax is always taxing:
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By Luke5
10th Aug 2021 08:32

I’d of thought around the same because I think they value the balloon payment at what they think the car will be worth at the end of the contract

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By Tax is always taxing
10th Aug 2021 09:11

Its not always the case, sometimes they are artificially low and below MV, therefore any sensible buyer would take the option - therefore its all capital from start.
Conversely it can be set high and more than the vehicle is worth, therefore it is treated as a rental.
If its at market value, then I believe its treated as the supply of services.

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By Luke5
10th Aug 2021 09:29

It definitely doesn’t look artificially low

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By Tax is always taxing
10th Aug 2021 09:48

How is the supplier treating it.
Is the VAT settled upfront, or is there VAT on the monthly PCP payment?

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By SXGuy
10th Aug 2021 11:43

Sometimes they enflate the balloon to lower the monthly cost. I wouldn't just take it as red that it will be worth the same in 4 years. Id want to look at market prices for similar model that's 4 years old.

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By paulwakefield1
10th Aug 2021 08:45

With these types of contract, my starting point is capitalise for compulsory balloon payments and operating lease for optional balloon payments and then look for contra indications (e.g. an artificially low optional balloon).

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Replying to paulwakefield1:
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By Luke5
10th Aug 2021 09:08

Cheers, the thing leaning me towards accounting for it as a finance lease is the risks and rewards are with the leasee and on the documentation in the ‘type of credit’ box it says hire purchase

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By paul.benny
10th Aug 2021 09:13

Always helps to look at the accounting standards...

The test under FRS102 is that a contract is a finance lease (which should be capitalised) if it transfers substantially all of the risks and rewards of ownership. Paras 20.5-20.6 set out some indicators of whether that test is met.

Here the customer has exclusive use of the vehicle for the entire contract term. At 4 years, this is roughly half the useful economic life. The customer must insure and maintain the vehicle. There is a modest downside risk for the provider that the market value is less than the balloon payment.

On balance, I think this is a finance lease. The value to be capitalised is the fair value of minimum lease payments, including deposit; not the value of the vehicle - see para 20.9.

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Replying to paul.benny:
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By Luke5
10th Aug 2021 09:29

Ok, thank you!

So you’d capitalise the £1,500 deposit and £48 x £150.49?

What would then happen if the balloon payment option was taken up?

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Replying to Luke5:
paddle steamer
By DJKL
10th Aug 2021 09:55

You capitalise the whole price including the Balloon Payment, so

Dr Fixed Asset
Cr Cash re deposit
Cr HP Creditor (which will not be 48x 150.49 plus Balloon payment as the £150.49 payments will include interest)

EDIT- with £1500 deposit plus £7,223.52 (48x£150.49) plus £5,500 this totals £14,223.52, what would be the cost of the car if purchased outright right now?

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By Luke5
10th Aug 2021 09:58

I’d have thought about £9,500

Do you think it’s a finance or operating lease?

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paddle steamer
By DJKL
10th Aug 2021 10:25

Why such a difference, what does the party get besides use of the car?

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By paul.benny
10th Aug 2021 10:09

With respect (and I do respect your contributions), para 20.9 says

"At the commencement of the lease term, a lessee shall recognise its rights of use and obligations under finance leases as assets and liabilities in its statement of financial position at amounts equal to the fair value of the leased asset or, if lower, the present value of the minimum lease payments, determined at the inception of the lease."

A optional balloon shouldn't be capitalised, unless it's so low that customer will inevitably take up.

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By Luke5
10th Aug 2021 10:14

How would you account for the balloon payment if this was taken up?

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Replying to paul.benny:
paddle steamer
By DJKL
10th Aug 2021 10:24

With respect, and I do respect your posts, my starting double entry would be as described, how I might then adjust such a posting would then depend on what accounting framework I then used and I would reflect any valuation adjustments that are appropriate as part of the year end process, frankly I never enter transactions with an eye to standards, I enter transactions and then consider what and how I need to disclose that as a year ends(maybe this is just me)

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By paulwakefield1
10th Aug 2021 09:39

Whilst I can see my fellow Paul's argument (and with the caveat that there are not any other significant clauses in the agreement), I lean towards an operating lease on the grounds it fails the examples in FRS 102 20.5 except (e) as well as 20.6 (b) .

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Replying to paulwakefield1:
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By Luke5
10th Aug 2021 09:43

So you’d put the deposit and monthly payments to car hire on the P&L and if the balloon payment is taken up, capitalise this amount?

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By paul.benny
10th Aug 2021 10:39

Clearly there are some divergent views here.

The test in FRS102 is that "A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership." You must decide whether that's the case, and if so, the standard is clear about how the contract should be accounted for.

Some of my esteemed colleagues here appear to be going on what they think is right rather the requirements of the Standard.

FWIW, IFRS16 does away with the concept of an operating lease, save for short term rentals (eg hire cars) and de minimis (eg franking machine)

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Replying to paul.benny:
paddle steamer
By DJKL
10th Aug 2021 10:47

Paul, has the OP actually said under what standard they are reporting?

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By paul.benny
10th Aug 2021 13:27

As we both know, the OP hasn't mentioned the reporting regime. Your point is?

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paddle steamer
By DJKL
10th Aug 2021 13:42

My point is you have no way of knowing how you will recognise anything until they do.

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By Luke5
10th Aug 2021 12:39

It’s a tough one because the risks and rewards have been transferred, however, it isn’t a small payment at the end

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paddle steamer
By DJKL
10th Aug 2021 13:41

"the lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable
for it to be reasonably certain, at the inception of the lease, that the option will
be exercised;"

Not sure of your £9.5 initial value as that puts finance costs very high in percentage terms, but after 4 years what value?

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Replying to Luke5:
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By paul.benny
10th Aug 2021 13:41

It can be hard to get your head round this - you're not capitalising a vehicle, but the right to use a vehicle for four years. That means that at the end of the term, you hand the vehicle back and have a fully written down asset in your balance sheet.

If you then exercise the option, you're effectively buying a "new" asset, being a four year old vehicle for the balloon amount.

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Replying to paul.benny:
Melchett
By thestudyman
11th Aug 2021 12:15

paul.benny wrote:

Clearly there are some divergent views here.

The test in FRS102 is that "A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership." You must decide whether that's the case, and if so, the standard is clear about how the contract should be accounted for.

Some of my esteemed colleagues here appear to be going on what they think is right rather the requirements of the Standard.

FWIW, IFRS16 does away with the concept of an operating lease, save for short term rentals (eg hire cars) and de minimis (eg franking machine)

I do like IFRS 16 in that aspect, we can do away with (almost) all operating leases. Nearly all leases will be on the balance sheet and follow a general uniform accounting treatment.

At the last triennial review, the FRC deferred incorporating ifrs 16 into UK Gaap, and unfortunately it will still be a while before we see this: https://www.frc.org.uk/getattachment/fad30eea-aa8f-4961-beda-a7d8128e316...(Dec-2018).pdf

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By birdman
11th Aug 2021 09:47

Is it just me that gets depressed at the sheer pointlessness of all the above for your average small Company? The MTD entries where an accountant isn't involved (or even when one is, perhaps ;) ) will be interesting....

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By Iamarobot
11th Aug 2021 11:01

Good point. I bet a lot of Xero users will post the deposit to an asset code because deposits get returned (like a house rental deposit)
The monthlies will go to motor expenses and the VAT recovered.
The balloon will never be paid because the car dealer (like a drug dealer) will switch them into a new car before end of the 4 year term.

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By birdman
11th Aug 2021 11:10

deleted

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