Sales-type Lease & Direct Financing Lease

Sales-type lease:
The lessor is also the producer or dealer who has sold the lease, ie include manufacturing & selling profit. In this case:

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.

At inception:
sales = PV of lease payments
COGS= (Cost of asset leased – PV of estimated salvage value)
Gross profit = (Selling price - Cost of the asset)

Note:
· The gross profit is recorded in income statement, +CFO, -CFI, no change in total CF

Asset: net investment in the lease = PV of future lease payments + estimated salvage value

During lease term:
Interest income: A part of the lease payment is booked as interest income affecting CFO; the rest is used to amortize the net value of the lease.

Interest income = Implicit interest rate x Net value of lease remaining},
Where: the implicit interest rate is the rate at which PV of MLPs = Selling price of asset.

End of each year:
Substract net investment in lease the difference between the lease payment AND the interest income, affecting CFI.

Direct-financing lease:
· The lessor is not the producer or dealer who sold the lease.
· No sale or gross profit is recognized at inception.
· The lease is recorded with reduction in inventory and increase in lease receivables.
· A part of lease payment is booked as interest income and the rest is used to reduce the lease receivable:

• Interest income = Implicit interest rate x Net value of lease remaining)
• The implicit interest rate is the rate at which PV of MLPs = Cost of asset.