Finance or Operating Lease?

[She11]

I am unsure how to record a new van in the business.

We have an agreement for 36 months at which point the van gets given back. We have paid an initial deposit or 9 x the monthly fee and then have a further 35 monthly payments. Am I right in thinking that this is classed in the accounts as an operating lease as we are giving it back?

 

[Scalloway]

Not necessarily. If you are responsible for the upkeep while it is in your possession then it is a finance lease.

https://maxxia.co.uk/blog/finance-lease-vs-operating-lease/

 

[Mark T Jones]

Not necessarily. If you are responsible for the upkeep while it is in your possession then it is a finance lease.

https://maxxia.co.uk/blog/finance-lease-vs-operating-lease/

Possibly some confusion there

An operating lease may or may not include maintenance

The main indicator is in the risk of ownership - in this case, whether the RV is a set sum, or simply a non guaranteed balloon payment

 

[Nsarah6]

Leasing companies hold slightly different rules around something being an operating lease or a finance lease. Usually, if the present value of all lease payments do not exceed the cash price at time of purchase and you're not going to be owning the equipment at the end of the lease - then it's an operating lease. However some accountants deem any lease whereby title does not pass to the lessee at the end of term as an operating lease.

 

[UK Contractor Accountant]

Below is the Financial Reporting guidelines for finance leases under UK GAAP:

'The Guidance Notes to SSAP 21 contain a 90% test whereby should the present value of the minimum lease payments that the lessee is required to pay equate to 90% or more of the fair value of the leased asset then this will give rise to a finance lease. However, FRS 102 Section 20 does not contain any 90% benchmark that we currently see in SSAP 21; instead it offers five examples of situations that individually, or in combination, would normally lead to a lease being classified as a finance lease, and a further three indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease. The first five are as follows:

• The lease transfers ownership of the asset to the lessee by the end of the lease term;
• 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;
• The lease term is for the major part of the economic life of the asset even if title is not transferred;
• At the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and
• The leased assets are of such a specialised nature that only the lessee can use them without major modifications.

You may note that the fourth bullet point above refers to the term ‘substantially all’. This is the term that has essentially replaced the 90% test contained in SSAP 21, hence more judgement will be needed on the part of the accountant.

The three additional indicators of situations that could also lead to classification of a lease as a finance lease are as follows:

• If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;
• Gains or losses from the fluctuation in the residual value of the leased asset accrue to the lessee (eg in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and
• The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.'