Sales-type lease accounting
/What is the Accounting for a Sales-Type Lease?
In a sales-type lease, the lessor is assumed to actually be selling a product to the lessee, which calls for the recognition of a profit or loss on the sale. Consequently, this results in the following accounting at the commencement date of the lease:
Derecognize asset. The lessor derecognizes the underlying asset, since it is assumed to have been sold to the lessee.
Recognize net investment. The lessor recognizes a net investment in the lease. This investment includes the following:
The present value of lease payments not yet received
The present value of the guaranteed amount of the underlying asset’s residual value at the end of the lease term
The present value of the unguaranteed amount of the underlying asset’s residual value at the end of the lease term
Recognize profit or loss. The lessor recognizes any selling profit or loss caused by the lease.
Recognize initial direct costs. The lessor recognizes any initial direct costs as an expense, if there is a difference between the carrying amount of the underlying asset and its fair value. If the fair value of the underlying asset is instead equal to its carrying amount, then defer the initial direct costs and include them in the measurement of the lessor’s investment in the lease.
Related AccountingTools Course
In addition, the lessor must account for the following items subsequent to the commencement date of the lease:
Interest income. The ongoing amount of interest earned on the net investment in the lease.
Variable lease payments. If there are any variable lease payments that were not included in the net investment in the lease, record them in profit or loss in the same reporting period as the events that triggered the payments.
Impairment. Recognize any impairment of the net investment in the lease.
Net investment. Adjust the balance of the net investment in the lease by adding interest income and subtracting any lease payments collected during the period.
If this type of lease is terminated before the end of its lease term, the lessor must test the net investment in the lease for impairment and recognize an impairment loss if necessary. Then reclassify the net investment in the lease to the most appropriate fixed asset category. The reclassified asset is recorded at the sum of the carrying amounts of the lease receivable and the residual asset.
At the end of the lease term, the lessor reclassifies its net investment in the lease to the most appropriate fixed asset account.
Example of a Sales-Type Lease
Capital Inc. enters into an eight-year lease of equipment with a lessee. Under the terms of the agreement, Capital will receive an annual lease payment of $10,000, payable at the end of each year. The lessee also provides Capital with a residual value guarantee of $15,000. Upon reviewing the credit rating of the lessee, Capital’s controller concludes that it is probable that Capital will collect the lease payments and any additional funding necessary to satisfy the lessee’s residual value guarantee. Additional pertinent facts are:
The equipment has a 10-year estimated economic life
The equipment has a carrying amount of $60,000
The equipment has a fair value of $71,509 at the commencement date
The expected residual value of the equipment is $18,000 at the end of the lease term
There is no transfer of equipment ownership to the lessee, nor is there a purchase option
The rate implicit in the lease is 6%
The controller classifies the lease as a sales-type lease, because the combined present value of the lease payments and the residual value guaranteed by the lessee is $71,509, which is substantially all of the fair value of the underlying asset.
The controller measures the net investment in the lease at $73,391 at the commencement date of the lease; this equals the fair value of the equipment. This net investment consists of the following:
The selling profit on the lease is $13,391, which is the difference between the lease receivable (the present values of the lease payments and the guaranteed residual value) and the carrying amount of the equipment net of the unguaranteed residual asset. The calculation is:
At the lease commencement date, the controller derecognizes the $60,000 carrying amount of the equipment, recognizes the net investment in the lease of $73,391, and recognizes the selling profit of $13,391.
At the end of the first year of the lease, Capital receives and recognizes the annual $10,000 lease payment. Capital also recognizes interest on the net investment in the lease, which is $4,403 (calculated as $73,391 net investment in the lease × 6% rate implicit in the lease). This results in a reduced balance of $67,794 in the net investment in the lease, which is calculated as the $73,391 beginning balance, plus the $4,403 interest income, minus the $10,000 lease payment.
Related Articles
The Difference Between a Finance Lease and an Operating Lease