A lessor (the leasing company) can account for a lease in three ways:
- Operating lease
- Direct-financing lease
- Sales-type lease
Lease capitalization, which includes the direct-financing lease and the sales-type lease, needs to be recognized when a lease meets any one of the four criteria specified for capitalization of leases and both of the following revenues-recognition criteria:
- Collection of the monthly lease payments is reasonably predictable.
- Lessor's performance is substantially complete, or future costs are reasonably predictable.
If the lease is accounted for as a capital lease, the lessor must determine if it classifies as a direct-finance lease or as a sales-type lease. To classify as a sales-type lease, the fair value of the asset must be greater than the lessor's book value. If not, it is accounted for as a direct-financing lease.
As its name implies, a direct-financing lease is basically the coupling of a sale and financing transaction. In this case, the lessor removes the leased asset from its books and replaces it with a receivable from the lessee.
The only income recognized by the lessor is the interest received. The implied rate is taken by calculating IRR of the asset; cash inflow is equal to lease payments and cash outflow is equal to the book value of the lease asset.
A sales-type lease is accounted for like a direct-financing lease, except that profit on a sale is recognized upon inception of the lease, in addition to the interest income recognized during the lease term. The gross profit recognized at the inception of the lease is the PV of all lease payments minus the cost of the leased asset.
InvestingOperating lease is a term used mostly in accounting to denote a lease that gives the lessee rights to use and operate an asset without ownership.
Managing WealthA lease considered to have the economic characteristics of asset ownership.
Personal FinanceFor those who no longer want their car for whatever reason, transferring the lease to an interested party can be a particularly appealing choice.
Personal FinancePeople who lease a car are often more concerned with the short-term picture.
Personal FinanceLeasing a car isn't right for everyone. But it's attractive for those who want low initial payments and the ability to get a new vehicle every few years.
RetirementTo buy or lease – that is the question. For retirees, access to safer cars, comprehensive warranties and tax deductions may drive up leasing's appeal.
Personal FinanceWhile leasing has certain advantages, buying a car tends to save you money in the long run and offers greater flexibility.
InvestingUnderstand how financing through operating leases, synthetic leases, and securitizations affects companies' image of performance.
Managing WealthThese two major ways to obtain a car have very different advantages and drawbacks. Find out which is best for you.
Personal FinanceA lease is an agreement between two parties where the lessor owns property that it allows the lessee to use pursuant to terms of the agreement.