Example of Interest on Finance Lease

Example of Interest on Finance Lease

Interest on Finance lease is a finance charge and accounted for at the year as operating expenses. The expenses is charged using actuarial method i.e. (calculated over the outstanding liability). It is not appropriate to account for the interest at the time of initial recognition (it is a wrong treatment) because interest is to be calculated on the outstanding liability during the period.

Example

Car Lease agreement	3 year
Fair value of Car	20,000
Lease rental ( 3 year @ 8,000)	24,000
Interest Rate	10%
Calculate the interest for 2014

Solution

1. Wrong Accounting Treatment: it is wrong to recognize the asset at amount of total payment payable under finance lease and to include the amount of interest into the cost of asset.

Date	Particulars	Dr	Cr
	Assets	24,000
	Finance liability		20,000
	Interest Payable		4,000

2. Right Accounting Treatment

The asset is accounted for at the fair value of asset and liability is recognized with this amount. The interest amount is separately calculated at the year end.

i. Initial Recognition (01 Jan, 2014)

Date	Particulars	Dr	Cr
	Assets	20,000
	Finance liability		20,000

ii. Interest Recognition

The interest is recognized at the end of year calculated on the outstanding liability during the year i.e. (10% of 20,000 = $ 2000)

Date	Particulars	Dr	Cr
	Interest	2,000
	Interest Payable		2,000