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:
- Gross amount of investment in the lease
- Initial direct costs
+ Present value of unguaranteed residual value benefiting the lessor
= Unearned income
- 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.