Liabilities - Accounting For Leases

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.

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.

Sales-Type Lease
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.

Introduction


Related Articles
  1. Home & Auto

    When Is Buying A Car Better Than Leasing?

    People who lease a car are often more concerned with the short-term picture.
  2. Savings

    When Is Leasing A Car Your Best Bet?

    Leasing 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.
  3. Savings

    Why You Should Buy A Car Instead Of Leasing

    While leasing has certain advantages, buying a car tends to save you money in the long run and offers greater flexibility.
  4. Home & Auto

    New Wheels: Lease Or Buy?

    These two major ways to obtain a car have very different advantages and drawbacks. Find out which is best for you.
  5. Credit & Loans

    How Does a Lease Work?

    A 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.
  6. Investing News

    Auto Leasing Hits Record High in Q4

    Auto Leasing is continuously growing in popularity as a preferred choice of financing.
  7. Investing News

    Auto Leasing Hits Record High in Q4

    On Thursday, Experian Automotive – a company that tracks financing options for new and used vehicles – released a report that highlights more consumers are leasing, rather than buying, new or ...
  8. Savings

    Your Lease Is Up: When Should You Buy The Car?

    In general, the fact that you know the car is to your benefit. Before deciding, compare the buyback price to what the car would go for on the open market.
  9. Stock Analysis

    AerCap An Interesting Play On Commercial Aviation Recovery

    While plenty is written on commercial aerospace plays, the large airplane leasing companies don't get the same attention. With attractive financing, improving leases, and strengthening trends, ...
  10. Home & Auto

    6 Ways Businesses Take Advantage Of Real Estate

    Businesses often prefer to lease rather than purchase properties, in order to avoid tying up cash.
RELATED TERMS
  1. Capital Lease

    A lease considered to have the economic characteristics of asset ...
  2. Operating Lease

    A contract that allows for the use of an asset, but does not ...
  3. Closed-End Lease

    A rental agreement that puts no obligation on the lessee (the ...
  4. Lease Utilization

    A financial ratio that measures how much a company uses leasing ...
  5. Walk-Away Lease

    A common type of car lease in which the lessee returns the car ...
  6. Fixed Price Purchase Option

    The right, but not the obligation, to buy a leased item at a ...
RELATED FAQS
  1. Why might a bond agreement limit the amount of assets that the firm can lease?

    Bond covenants can limit the amount of leases a company can have because leasing contracts are a form of debt. Taking on ... Read Answer >>
  2. You are currently reviewing the following information for JKL Corp ...

    Free info on financial certification exams including study guides, exam questions, and much more! Read Answer >>
  3. How does the value of the real estate impact the value of a triple net (NNN) lease?

    Understand how the value of the real estate involved in a triple-net lease impacts the value of the lease both positively ... Read Answer >>
  4. I have a small business, and I'm considering setting up an SEP IRA. What are leased ...

    Generally, a leased employee is the employee of an outside organization from which you lease the employee's services. For ... Read Answer >>
  5. What is the importance of residual value in an automobile lease?

    Find out how dealerships assign residual value and why this is an important factor in car leases. Learn about a tactic some ... Read Answer >>
  6. What are typical forms of long-term debt for a public company?

    Learn typical forms of long-term debt for a public company, such as bonds, term loans, paid-in-kind notes, leases and hybrid ... Read Answer >>
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center