Leasing is a way of raising finance (as opposed to traditional renting) to purchase outright or purchase the use of an asset.
This article excludes leases over 5 years and car leases where tax treatment differs.
The Lease period may vary from 1 to 5 years depending on the life of the asset.
The Lessor is the business providing the asset.
The Lessee is the business using the asset.
There are two types of Leases available, both of which are accounted for differently.
Finance Lease
Under a finance Lease an asset is shown on the balance sheet. This is not an owned asset, but the rights to an asset. Usually the Lessee has most of the risk and reward but does not actually own the title of the asset during the leasing period. Once the leasing period expires, title to the asset passes to the lessee (normally for a small payment).
The accounting entries are:
Debit the fixed asset account
Credit the lease loan account (liability of payments due) excluding the interest charge.
When a payment is made, the entries will be:
Debit lease loan account (excluding interest)
Debit VAT account (input VAT)
Debit loan interest
Credit bank
The depreciation for the year is reflected in the accounts as:
Debit the depreciation account in the P&L
Credit the provision of fixed asset account in Balance sheet
The depreciation is disallowed for tax purposes but the lease payments are allowed as an expenses.
Normally, these two costs contra out.
Operating Lease
An operating lease is where a business leases the asset for a shorter period than the useful life of the asset, usually where the asset is required on a short term contract hire basis.
The Lessor retains the legal ownership, risk and reward of the asset and is required to service and maintain the asset.
The asset is not reflected in the accounts, and a depreciation charge is not applicable.
The payments are treated as a rental and are deducted as an expense in the profit and loss account.
The accounting entry for the monthly payment is:
Debit leasing rental account (e.g. equipment)
Debit VAT account (input VAT)
Credit Bank