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Accounting for leases

Initial direct costs may be more significant for a lessor because they are usually the party that solicits
lessees as part of their sales activities, are often the party to engage attorneys to prepare the legal
documents, and often pay commissions incurred in connection with execution of a lease. See LG
4.2.2.2 for information on initial direct costs and Figure 4-1 for the examples of costs included and
excluded from initial direct costs.

A lessor should expense the initial direct costs associated with a sales-type lease unless the fair value of
the underlying asset equals its carrying amount (i.e., there is no selling profit or loss). This accounting
is similar to the accounting for a seller’s costs in a contract for similar goods. See RR 11.2 for
information on a seller’s accounting for contract costs.

Initial direct costs incurred in connection with a sales-type lease with no selling profit or loss should
be deferred and recognized over the lease term using a method that produces a constant periodic rate
of return on the lease when combined with the interest income on the lease receivable and the residual
asset (i.e., in the same manner as for a direct financing lease).

In arrangements that include both lease and nonlease components, the initial direct costs should be
allocated to the various components and accounted for in accordance with the guidance applicable to
each component. Initial direct costs may be treated differently depending upon the nature of the
nonlease components.

4.3.1.3 When collectibility is not probable at the commencement date for a sales-type lease

ASC 842-30-25-3 to 25-6 describes how a lessor should recognize and measure a sales-type lease when
collectibility of the lease receivable is not probable at the commencement date.

ASC 842-30-25-3
The guidance in paragraphs 842-30-25-1 through 25-2 notwithstanding, if collectibility of the lease
payments, plus any amount necessary to satisfy a residual value guarantee provided by the lessee, is
not probable at the commencement date, the lessor shall not derecognize the underlying asset but
shall recognize lease payments received—including variable lease payments—as a deposit liability until
the earlier of either of the following:
a. Collectibility of the lease payments, plus any amount necessary to satisfy a residual value
guarantee provided by the lessee, becomes probable. If collectibility is not probable at the
commencement date, a lessor shall continue to assess collectibility to determine whether the lease
payments and any amount necessary to satisfy a residual value guarantee are probable of
collection.
b. Either of the following events occurs:

1. The contract has been terminated, and the lease payments received from the lessee are
nonrefundable.
2. The lessor has repossessed the underlying asset, it has no further obligation under the contract
to the lessee, and the lease payments received from the lessee are nonrefundable.

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