Sales-type lease accounting

A lease is classified as a sales-type lease by the lessor when the fair value of the leased property at the start of a lease varies from its carrying amount, it involves real estate, and there is a transfer of ownership to the lessee by the end of the lease term. Alternatively, a qualifying lease may not involve real estate  and is classified as an operating lease. This classification is typically used when a manufacturer or a dealer uses a lease as a tool for marketing what they sell.

If the lessor has classified a lease as a sales-type lease and the asset being leased is real estate, account for the transaction as though the lessor is selling the property.

If the transaction is classified as a sales-type lease and it does not involve real estate, the lessor should account for the transaction by recognizing the following:

   Sale price

- Gross amount of investment in the lease

- Initial direct costs

+ Present value of unguaranteed residual value benefiting the lessor

= Unearned income

Where,

  • The sale price is calculated as the present value of minimum lease payments, net of executory costs, discounted using the interest rate implicit in the lease.
  • The gross amount of the investment in the lease is calculated as:

Sum of minimum lease payments, less executory cost component

 + Unguaranteed residual value benefiting lessor

Unearned income is recognized in earnings over the term of the lease. Use the interest method to recognize that amount of unearned income that produces a constant rate of return over the lease term. If the lessor will benefit from a residual value guarantee or penalty from a failure to renew the lease, the interest method should be calculated to leave the amount of the guarantee or penalty outstanding at the end of the lease term.

If a lease originally classified as a sales-type lease is renewed and the renewed lease is classified as an operating lease, the lessor should continue to account for the original lease as a sales-type lease, and then account for the renewed lease as an operating lease.

If the remaining minimum lease payments of a sales-type lease are subsequently altered, change the minimum lease payments receivable, with the offset charged to unearned income. If the change constitutes a new lease, terminate the accounting for the old lease and account for the post-change lease as a new lease.