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Accounting for leases

For sales-type and direct financing leases, lessors record interest income on the net investment in
addition to any selling profit or loss; however, the timing for recognizing any selling profit or loss
differs. In a sales-type lease that transfers control to the lessee, selling profit or loss should be
recognized at lease commencement. In a direct financing lease, a selling loss is recognized at lease
commencement, but selling profit is deferred and recognized over the lease term.

In operating leases, lessors record lease income on a straight-line basis over the lease term.

4.5.1 Lessor sales-type leases and direct financing lease

The lessor in both a sales-type lease and direct financing lease should measure its net investment in a
lease on an amortized cost basis subsequent to initially recording the lease.

For sales-type leases, in which a transfer of control occurs, any selling profit or loss is recognized at the
commencement date. Therefore, the only income statement effect during the lease term results from
recognizing interest income on the lease receivable and accretion on the unguaranteed residual asset.

For direct financing leases, a transfer of control does not occur, so selling profit is not recognized at
the commencement date, but is instead recognized over the lease term (a selling loss is recognized at
the commencement date). Therefore, any deferred profit is recognized in addition to the interest
income on the lease receivable and accretion on the unguaranteed residual asset.

Interest on the lease receivable is calculated by multiplying the rate implicit in the lease by the
outstanding receivable balance each period. The receivable is increased for accrued interest and
reduced by cash payments received from the lessee.

The residual asset is recorded at its present value and accreted to its final expected value at the
expiration of the lease term also using the rate implicit in the lease.

Example 4-14 illustrates the application of this guidance.
EXAMPLE 4-14

Sales-type lease subsequent measurement and recognition – non-specialized digital imaging
equipment lease (lessor)

This example is a continuation of Example 4-7.

The lease is classified as a sales-type lease as the lease payments represent substantially all of the fair
value of the asset. The net investment in the lease is $3,900 (lease receivable of $3,722 plus an
unguaranteed residual asset of $178). Since control has been deemed to have transferred to Lessee
Corp, profit is recognized by Lessor Corp at lease commencement.

How would Lessor Corp account for the leasing transaction after lease commencement?

Analysis

Lessor Corp would first schedule out the cash flows on the lease receivable as shown in the following
table.

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