Introduction

The accounting standard dealing with this topic is IAS 17 ‘Leases’. Its UK GAAP counterpart, SSAP 21 ‘Accounting for leases and hire purchase contracts’, is very similar, taking the same overall approach, although there are some differences between the two standards – see ‘Leases under UK GAAP’ below.

IAS 17 was issued in 1982 and SSAP 21 two years later. These were the first international and UK accounting standards explicitly to require the substance, rather than the legal form, of a transaction to be reflected in the accounting treatment. A decade later in the UK, FRS 5 set out a much more comprehensive role for substance over form. This has no IFRS equivalent; hence substance over form, while referred to in the frameworks of both bodies, is a stronger notion in UK GAAP than in IFRS. Nevertheless, this does not detract from the stance taken in IAS 17.

In a nutshell, IAS 17 and SSAP 21 both divide leases into two categories, finance leases and operating leases, with different accounting treatments for each. With a finance lease, a lessee is in substance buying the asset and paying on deferred terms in the same way as it would if it took out a loan to buy the asset and was then repaying the loan. Accordingly, the standards require the asset to be capitalised by the lessee (and depreciated over its useful economic life or, if shorter, the lease term) and the related obligation to be recognised on the lessee's balance sheet as equivalent to a loan.