BLM13010 - Lease accounting: finance lease accounting: outline
Source: gov.uk (2025-08-28)


This manual is being updated to reflect FRS 102 (2024 amendments). For guidance on the tax treatment of accounts prepared under IFRS 16 or the revised FRS 102, please refer to pages within the BLM50000 (https://www.gov.uk/hmrc-internal-manuals/business-leasing-manual/blm50000) chapter.

This section is applicable to entities applying FRS 102 pre 2024 amendments or FRS 105, and for lessors only under IFRS 16 and FRS 102 (2024 amendments).

See BLM17000 (https://www.gov.uk/hmrc-internal-manuals/business-leasing-manual/blm17000) for lessee accounting under the on-balance sheet model under IFRS 16 and FRS 102 (2024 amendments).

Accounting standards for leasing were introduced to address the problem of what is commonly referred to as ‘off balance sheet financing’. One of the main aims of such arrangements is to finance a business’s assets and operations in such a way that the finance is not shown as a liability in the business’s balance sheet. A further effect is that the assets being financed are excluded from the accounts, with the result that both the resources of the entity and its financing are understated.

Therefore, accountants must look at the commercial reality and treat a finance lease much as if it were a loan by a lessor to a lessee which the lessee uses to buy the asset. That is, the accounting follows the substance of the transaction rather than its legal form.

Finance lessor

A finance lessor's accounts show no physical asset in its balance sheet even though it owns the leased asset. Instead, the lessor shows its financial investment in the lease (in substance, the 'loan' outstanding) as its asset.

The ‘loan’ is equal to the remaining capital instalments due under the lease. At the outset the 'loan' will generally be equal to the cost of the asset bought by the lessor. The finance lessor's earnings are the 'interest' on the loan (the interest element in the rentals):

the capital element in the rentals is the ‘loan repayments’ which go to the balance sheet to write down the debt;

the 'interest' earnings are allocated to each year in proportion to the outstanding debt in each year, resulting in higher ‘interest’ earnings in the earlier years of the arrangement. The ‘interest’ is recognised in profit and loss.

Finance lessee (applicable to FRS 102 (pre 2024 amendments) and FRS 105 only

The finance lessee does not own the asset but shows it in its balance sheet as if it did (which is the economic substance if not, technically, the legal position).

The finance lessee also shows the capital owed to the finance lessor as a liability in its balance sheet.

In its profit and loss account the finance lessee:

charges the 'interest' element in the rentals to profit and loss in the same way as any other loan interest,

does not charge the capital element in the rentals: they are treated as loan repayments which go to reduce the debt to the finance lessor included in the balance sheet, but instead charges depreciation on the asset.

The timing of the deductions is important. For finance leases:

the interest is deducted by the finance lessee as it accrues with more interest due earlier reflecting the higher liability earlier in the term; and

the depreciation deduction depends on the life of the asset or the life of the lease if there is no certainty that the lessee will obtain ownership of the asset. Depreciation is calculated in accordance with the relevant accounting standard.

Off balance sheet finance remains available using specialised operating leases, see BLM11216 (https://www.gov.uk/hmrc-internal-manuals/business-leasing-manual/blm11216).

The accountancy treatment has no effect on the lessor’s entitlement to claim capital allowances (which depends on the legal ownership) except where the lease is a long funding lease, see BLM20000 (https://www.gov.uk/hmrc-internal-manuals/business-leasing-manual/blm20000) onwards, or falls within CAA01/S67, see BLM39000 (https://www.gov.uk/hmrc-internal-manuals/business-leasing-manual/blm39000) onwards.