A sale followed by a leaseback in the form of a finance lease
can result in a profit if the capital value attributed to the asset
for the purposes of the lease is higher than the carrying value of
the asset in the books of the vendor/lessee up to the time of sale.
The Guidance Notes on SSAP 21 suggest that the situation can be
dealt with in one of two ways in the accounts of the vendor /
Under the first accounting method in SSAP 21 the asset (which is a capital asset of the vendor) is treated as sold and the profit amortised over the lease term.
The second accounting method in SSAP 21 regards the sale and leaseback transaction as a refinancing exercise. As this reflects the substance of the transaction, it is the ONLY METHOD now acceptable under FRS 5, which is mandatory for periods of account ending on or after 22 September 1994.
The transaction is regarded purely as a refinancing exercise. The asset is not treated as if it has been sold and the profit on sale is not taken. The asset stays in the vendor's balance sheet at its book value and the sale proceeds is shown as a creditor. Where this treatment is adopted and the asset remains in the balance sheet at book value the following tax adjustments are required.
Asset purchased for £50,000; this is an ordinary purchase and not a finance lease.
Useful life: ten years.
Depreciation rate: 10% per annum straight-line.
At the end of year 5 the owner sells the asset for £30,000 and leases it back under a five year finance lease. The asset is still expected to have a total life of ten years and so must be written down to nil by the end of Year 10. Rentals (excluding the finance charge element) are £6,000 p.a. payable in arrear.
Accounting treatment: sale not recognised - treated as refinancing
END OF YEAR 5:
Under the new finance lease, the capital repayment element in the rentals total £30,000 and this is payable over five years (Years 6 to 10 inclusive). The asset will be worth nothing at the end of ten years and so the full amount of these rentals has to be written off over this period. But, because the asset has stayed in the balance sheet at its existing written down value of £25,000, the actual depreciation charge will only write off £25,000 by the end of year ten - a shortfall of £5,000.
The additional revenue rental deduction (£5,000) should be spread over years 6-10 using the actual rate of depreciation in the accounts as a guide. That is, in this case: