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Accounting for leases

The different ways of measuring the net investment in a lease for a sales-type lease and a direct
financing lease (i.e., a sales-type lease includes the selling profit recognized at commencement) results
in the same total income but differences in the timing of income recognition. Another difference in the
initial measurement of a net investment in a sales-type lease versus that recorded for a direct financing
lease is the accounting for initial direct costs. In a sales-type lease, these costs ordinarily are expensed
as incurred. In a direct financing lease, the initial direct costs are deferred and amortized over the term
of the lease, reducing interest income earned under the arrangement.

As discussed in LG 4.3.1.3, in a sales-type lease, collectibility only impacts sale recognition. In a direct
financing lease, however, collectibility impacts lease classification. As described in LG 3.3.4.7, when
collectibility of lease payments or the residual value guarantee is not probable at lease
commencement, a lessor should classify the lease as an operating lease, even though it would
otherwise have met the criteria for classification as a direct financing lease. The classification of such
leases are not reassessed when there is a subsequent improvement in the lessee’s credit quality (i.e.,
these operating leases remain classified as operating leases even when the collectibility subsequently
become probable). See LG 4.3.3.1 for the recognition and measurement of an operating lease when
collectibility is not probable.

4.3.3 Operating lease

An operating lease is neither a sale nor financing of an asset. The lessor should keep the asset
underlying the lease on its balance sheet and continue to depreciate the asset based on its estimated
useful life. Rental revenue should be recognized on a straight-line basis (or another systematic basis if
that basis is more representative of the pattern in which income is earned from the underlying asset
over the term of the respective lease). A lessor should record an unbilled rent receivable, which is the
amount by which straight-line rental revenue exceeds rents currently billed in accordance with the
lease.

4.3.3.1 Collectibility is not probable at the commencement date

ASC 842-30-25-12 describes the recognition and measurement for a lessor in an operating lease when
collectibility of the lease payments plus any amount necessary to satisfy the residual value guarantee is
not probable at the commencement date.

ASC 842-30-25-12
If collectibility of the lease payments plus any amount necessary to satisfy a residual value guarantee
(provided by the lessee or any other unrelated third party) is not probable at the commencement date,
lease income shall be limited to the lesser of the income that would be recognized in accordance with
paragraph 842-30-25-11(a) through (b) or the lease payments, including variable lease payments, that
have been collected from the lessee.
ASC 842-30-25-13
If the assessment of collectibility changes after the commencement date, any difference between the
lease income that would have been recognized in accordance with paragraph 842-30-25-11(a) through
(b) and the lease payments, including variable lease payments, that have been collected from the lessee
shall be recognized as a current-period adjustment to lease income.

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