## Accounting for Finance Lease
In a Finance Lease the economic substance is that the lessee has purchased the asset financed by the lessor (as a lender). Journal entries must reflect this substance.
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### Lessor's Books — Acting as a 'Lender'
| Event | Debit | Credit |
|---|---|---|
| Inception — asset transferred | Lease Receivable A/c | Asset A/c |
| Year-end — interest accrued | Lease Receivable A/c | Interest Income (P&L) |
| Year-end — rental received | Cash / Bank A/c | Lease Receivable A/c |
Combined entry for rental received:
- Dr Cash/Bank
- Cr Interest Income (P&L)
- Cr Lease Receivable A/c
> The asset leaves the lessor's books at inception. The lessor's balance sheet now shows a financial asset (Lease Receivable) instead.
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### Lessee's Books — Acting as 'Borrower/Owner'
| Event | Debit | Credit |
|---|---|---|
| Inception — asset received | Asset A/c | Lease Liability (Payable) A/c |
| Year-end — interest accrued | Interest Expense (P&L) | Lease Liability A/c |
| Year-end — rental paid | Lease Liability A/c | Cash / Bank A/c |
| Year-end — depreciation | Depreciation (P&L) | Asset / PPE A/c |
Combined entry for rental paid:
- Dr Interest Expense (P&L)
- Dr Lease Liability A/c
- Cr Cash / Bank
> The asset enters the lessee's books at inception at the lower of PV of MLP or Fair Value.
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### Initial Measurement
| Party | Measurement of Asset / Receivable |
|---|---|
| Lessee — Asset | Lower of: (i) PV of MLP, (ii) Fair Value of Asset |
| Lessor — Lease Receivable | Net Investment in the Lease (= PV of MLP + PV of Unguaranteed Residual Value) |
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### Interest Allocation — Effective Interest Rate Method
Each rental payment is split into:
1. Interest (= Opening balance of Lease Receivable/Liability × Implicit Interest Rate)
2. Principal repayment (= Rental − Interest)