{m}.{s}.1Leasing: Accounting entries

The two types of leases are accounted for in different ways. In this section we will look at the recording of operating leases only. Finance leases are accounted for on a basis similar to the recording of hire purchase.

{m}.{s}.2Operating leases (rental)

The accounting entries to record these payments are very straightforward. The business does not own the asset, so the asset accounts are not affected. Instead it is paying a charge for the lease of the asset - this is a normal expense of the business. Thus we must open a new expense account - Leasing.

We will look at an example [{m}.{s}a].

 

Our example:

On 1 June 2008, Mr Waterman takes out a lease with the Weller Finance Co. for the rental of equipment for use in his plumber's business. Mr Waterman is registered for VAT. Under the terms of the lease, Mr Waterman pays a lump sum, equal to 3 months rental, of £720 plus VAT on the 1 June 2008. Thereafter he is to pay 33 monthly payments of £240 plus VAT, starting 1 July 2008.

Weller Finance Co
Leasing Agreement
  Lesee:  
  Mr Waterman, plumber
Canal St
Wellingborough
 
 
  Commencement of lease 01/06/08  
  Period of lease 36 months  
  Lease of equipment:  
  Initial payment 01/06/08 £720 + VAT  
  33 Monthly payments £240 + VAT  
  commencing 01/07/08    
 
[{m}.{s}a]

 

{m}.{s}.3

Step 1: Initial payment

The first step will be to open a leasing account.

1 June: he makes a payment of: £720 + VAT £72 = £792

 

Weller Finance Co
Leasing Agreement
  Lesee:  
  Mr Waterman, plumber
Canal St
Wellingborough
 
 
  Commencement of lease 01/06/08  
  Period of lease 36 months  
  Lease of equipment:  
  Initial payment 01/06/08 £720 + VAT  
  33 Monthly payments £240 + VAT  
  commencing 01/07/08    
 
[{m}.{s}b]

Step 2: First monthly payment

On 1 July he makes his first monthly payment of £264 of which the net amount £240 is transferred to the leasing account.

 

Weller Finance Co
Leasing Agreement
  Lesee:  
  Mr Waterman, plumber
Canal St
Wellingborough
 
 
  Commencement of lease 01/06/08  
  Period of lease 36 months  
  Lease of equipment:  
  Initial payment 01/06/08 £720 + VAT  
  33 Monthly payments £240 + VAT  
  commencing 01/07/08    
 
[{m}.{s}c]

Step 3: Further monthly payments

If Mr Waterman's year end is 30 September, he will make further payments of £264 on 1 August and 1 September.

 

Weller Finance Co
Leasing Agreement
  Lesee:  
  Mr Waterman, plumber
Canal St
Wellingborough
 
 
  Commencement of lease 01/06/08  
  Period of lease 36 months  
  Lease of equipment:  
  Initial payment 01/06/08 £720 + VAT  
  33 Monthly payments £240 + VAT  
  commencing 01/07/08    
 
[{m}.{s}d]

Step 4: Year end

At the year end, 30 September, the balance in the account will be transferred to the profit and loss account, as with any other expense account.

We must first, however, consider any accrual/prepayment position.

The number of months rental payments made so far = 6 (as there was an initial payment of 3 months rental).

The number of months the agreement has been in operation = 4 (Jun - Sep). We therefore have 2 months prepaid:
2 x 240 = £480
This is due to the extra 2 months paid at 1 June.

At 30 September we must therefore record the prepayment of £480.

 

Weller Finance Co
Leasing Agreement
  Lesee:  
  Mr Waterman, plumber
Canal St
Wellingborough
 
 
  Commencement of lease 01/06/08  
  Period of lease 36 months  
  Lease of equipment:  
  Initial payment 01/06/08 £720 + VAT  
  33 Monthly payments £240 + VAT  
  commencing 01/07/08    
 
[{m}.{s}e]

Step 5: Transfer to profit & loss

The balance in the account:


1440Dr - 480Cr = 960 Dr
(i.e. 4 x 240)


can now be transferred to the profit and loss account.

 

Leasing
1 June Bank72030 Sept Prept480
1 July Bank240 P&L Account 960
1 Aug Bank240    
1 Sept Bank 240   
      
      
[{m}.{s}f]

{m}.{s}.4Leasing: End of lease

The lease agreement will specify what is to happen at the end of the initial lease period - in the above case, 3 years.

Often the agreement continues on an annual basis, with a much reduced payment e.g. £50 p.a. being paid in years 4 onwards.

The agreement will also specify what is to happen if the business wishes to dispose of the asset during the initial lease period (the 3 years above). It will also specify what happens on disposal after the initial lease period. Often in the case of finance leases, the business will receive a high percentage of the sale proceeds (as a refund of leasing), with the balance of the proceeds being retained by the leasing company.