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The subsequent measurement of sales-type, direct financing, and operating leases differs significantly. As discussed in LG 4.3, in sales-type and direct financing leases, lessors replace the underlying asset on their balance sheet with a net investment in the lease, while in operating leases, lessors retain the underlying asset on their balance sheet.
For sales-type and direct financing leases, lessors record interest income on the net investment in addition to any selling profit or loss; however, the timing for recognizing any selling profit or loss differs. In a sales-type lease that transfers control to the lessee, selling profit or loss should be recognized at lease commencement. In a direct financing lease, a selling loss is recognized at lease commencement, but selling profit is deferred and recognized over the lease term. As discussed in LG 4.3.1.1 (for a sales-type lease) and LG 4.3.2.1 (for a direct financing lease), upon adoption of ASU 2021-05, ASC 842 requires a lessor to classify a lease with variable lease payments that do not depend on a rate or index as an operating lease at the lease commencement date if classifying the lease as a sales-type or direct financing lease would result in recognition of a selling loss. See LG 10.10 for the effective date and transition requirements of ASU 2021-05.
In operating leases, lessors record lease income on a straight-line basis over the lease term.
A lessor should recognize variable lease payments in the period in which they are earned for a lease classified as sales-type, direct financing, or operating.

4.5.1 Lessor sales-type leases and direct financing lease

The lessor in both a sales-type lease and direct financing lease should measure its net investment in a lease on an amortized cost basis subsequent to initially recording the lease.
For sales-type leases, in which a transfer of control occurs, any selling profit or loss is recognized at the commencement date (see LG 4.3.1.1 for the accounting for selling losses due to variable lease payments). Therefore, the only income statement effect during the lease term results from recognizing interest income on the lease receivable and accretion on the unguaranteed residual asset.
For direct financing leases, a transfer of control does not occur, so selling profit is not recognized at the commencement date, but is instead recognized over the lease term (a selling loss is recognized at the commencement date). Therefore, any deferred profit is recognized in addition to the interest income on the lease receivable and accretion on the unguaranteed residual asset. For a direct financing lease, a selling loss is recognized at lease commencement (see LG 4.3.2.1 for the accounting for selling losses due to variable lease payments).
Interest on the lease receivable is calculated by multiplying the rate implicit in the lease by the outstanding receivable balance each period. The receivable is increased for accrued interest and reduced by cash payments received from the lessee.
The unguaranteed residual asset is recorded at its present value and accreted to its final expected value at the expiration of the lease term also using the rate implicit in the lease.
Example LG 4-15 illustrates the subsequent measurement and recognition of a sales-type lease.
EXAMPLE LG 4-15
Sales-type lease subsequent measurement and recognition – non-specialized digital imaging equipment lease (lessor)
Lessor Corp enters into a lease of non-specialized digital imaging equipment with Lessee Corp on 1/1/X9. Lessor Corp is a manufacturer of digital imaging equipment that uses both direct sales and leases as a means of selling its products. The following table summarizes information about the lease and the leased assets.
Lease term
5 years, no renewal option
Remaining economic life of the leased equipment
6 years
Purchase option
None
Annual lease payments
$1,100
Payment date
Annually on January 1 (first payment is made at lease commencement)
Fair value of the leased equipment at commencement
$5,000
Lessor Corp’s carrying value of the leased equipment
$4,500
Rate implicit in the lease
7.04%
Other
  • Title to the asset remains with Lessor Corp upon lease expiration
  • Lessee Corp does not guarantee the residual value of the equipment at the end of the lease term and Lessor Corp does not obtain any third-party residual value insurance
  • Estimated fair value of the equipment at the end of the lease term is $250
  • Lessee Corp pays for all maintenance of the equipment separate from the lease
  • There are no initial direct costs incurred by Lessor Corp
  • Lessor Corp does not provide any incentives
How would Lessor Corp account for the leasing transaction after lease commencement?
Analysis
Based on the facts Lessor Corp could reasonably conclude that the lease is a sales-type lease as the lease term is a major part of the remaining economic life of the equipment (see LG 3.3 for lease classification criteria).
At commencement, Lessor Corp would first determine the total net investment in the lease as the present value of the lease receivable and the unguaranteed residual asset.
  • The present value of the lease receivable is equal to the present value of the remaining lease payments discounted at 7.04%; this amount is $3,722.
  • The present value of the unguaranteed residual asset discounted at 7.04% is $178.
  • Lessor Corp’s net investment in the lease is $3,900 (the sum of the lease receivable ($3,722) and the unguaranteed residual asset ($178)).
Since control has been deemed to have transferred to Lessee Corp, profit is recognized by Lessor Corp at lease commencement. The selling profit is calculated as follows:
Present value of the lease receivable
$3,722
Plus, the lease payment received at lease commencement
1,100
Less, the carrying value of leased asset ($4,500) net of unguaranteed residual asset ($178)
(4,322)
Selling profit
$500
Lessor Corp would record revenue at lease commencement equal to the lease receivable amount plus the lease payment received at lease commencement ($4,822). Cost of goods sold would be recorded as the difference between the carrying value of the leased asset ($4,500) and the discounted value of the unguaranteed residual asset ($178).
In order to account for the transaction after lease commencement, Lessor Corp would first schedule out the cash flows on the lease receivable as shown in the following table.
Payment
Interest income
Lease receivable
Lease commencement
$3,722
Year 1
*
$262
3,984
Year 2
1,100
203
3,087
Year 3
1,100
140
2,127
Year 4
1,100
73
1,100
Year 5
1,100
$4,400
$678
View table
* In year 1, payment was made at lease commencement, so it is not included in the lease receivable.
Interest paid to Lessor Corp at the beginning of year 2 would be accrued during year 1 (via a debit to lease receivable and credit to interest income).
Lessor Corp would also record accretion on the residual asset. Like the interest on the lease receivable, the accretion on the residual asset would be recorded during year 1 (via a debit to the residual asset and credit to income).
Accretion
Residual asset
Lease commencement
$178
Year 1
$13
191
Year 2
13
204
Year 3
14
218
Year 4
15
233
Year 5
17
250
$72
View table
Upon the expiration of the lease, Lessor Corp would reclassify the $250 net investment (which consists solely of the residual asset based on the Lessor Corp’s business model) as PP&E or inventory. The $250 represents Lessor Corp’s best estimate of the value of the asset established at the beginning of the lease.

4.5.2 Lessor operating leases

Since a lessor in an operating lease does not derecognize the underlying asset, it should continue to depreciate the asset in accordance with its normal depreciation policy. The lessor should record lease income on a straight-line basis over the lease term (unless another systematic and rational basis is more representative of the pattern in which benefit is expected to be derived from the use of the underlying asset). The difference between the cash received and the straight-line lease income recognized is recorded as rent receivable. If cash flows are higher than the lease income, deferred rent is recorded on the balance sheet. See LG 8.9 for the impact of collectibility of lease payments on a lessor’s pattern of revenue recognition for an operating lease.
Example LG 4-16 illustrates the subsequent measurement and recognition of operating lease for lessors.
EXAMPLE LG 4-16
Lessor operating lease subsequent measurement and recognition – automobile lease
Lessor Corp leases an automobile to Lessee Corp on January 1, 20X9. The following table summarizes information about the lease and the leased asset.
Lease term
3 years, no renewal option
Remaining economic life of the automobile
6 years
Fair value of the automobile at commencement
$30,000
Lessor Corp’s carrying value of the automobile at commencement
$30,000
Purchase option
Lessee Corp has the option to purchase the automobile at fair market value upon expiration of the lease.
Monthly lease payments
$500 for the first year

$550 for the second year

$600 for the third year
Payment date
Beginning of the month (first payment is made at lease commencement)
Rate implicit in the lease
8%
Other
  • Title to the automobile remains with Lessor Corp upon lease expiration
  • The expected residual value of the automobile at the end of the lease term is $19,000; Lessee Corp does not guarantee the residual value of the automobile at the end of the lease term
  • Lessee Corp pays for all maintenance of the automobile separate from the lease
  • There are no initial direct costs incurred by Lessor Corp
  • Lessor Corp does not provide any incentives

How would Lessor Corp account for the leasing transaction after lease commencement?
Analysis
Based on the facts Lessor Corp could reasonably conclude that this lease is an operating lease as none of the criteria for sales-type or direct financing lease treatment have been met (see LG 3.3 for lease classification criteria). As this is an operating lease, Lessor Corp would not record a net investment and would retain the automobile in property, plant, and equipment on its balance sheet, and it would continue to depreciate the asset.
Lessor Corp would likely determine that the most appropriate income recognition pattern is straight-line over the economic useful life of the asset (as no other systematic and rational basis is more representative of the pattern in which benefit is expected to be derived from the use of the underlying asset). As such, Lessor Corp would calculate the straight-line rental income per period by dividing the total rent payments to be made over the lease term by the total number of periods. In this example, the straight-line income Lessor Corp would record is $550 per month calculated as follows.
Monthly rent
Annual total
Year 1
$500
$6,000
Year 2
550
6,600
Year 3
600
7,200
$19,800
Number of periods
36
Straight-line rent per period
$550
View table
Lessor Corp would record the excess between the $550 monthly rental income and the actual rental payments required by the lease agreement in year one as deferred rent receivable on the balance sheet. Subsequently, any difference between the actual rental payments and the $550 monthly rental would reduce the deferred rent receivable. The following table shows the calculation of the deferred rent receivable at the end of each year. For the sake of simplicity, this table is shown on an annual basis; the actual schedule would be calculated on a monthly basis to match the frequency of lease payments.
Cash payments
(A)
Straight-line income
(B)
Increase (decrease)
(B – A)
Deferred rental receivable balance
Commencement
$ —
Year 1
$6,000
$6,600
$600
600
Year 2
6,600
6,600
600
Year 3
7,200
6,600
(600)
$19,800
$19,800
$ —
View table
Lessor Corp would continue to depreciate the underlying asset over the economic useful life of the asset.
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