Satisfying any of these criteria would normally lead to finance lease:
1. Transfer of ownership to the lessee at the end of the lease term.
2. Purchase option that is reasonably certain to be exercised.
3. Lease term forms a major part (at least 75%) of the asset’s useful life.
4. Present value(PV) of lease payments is a substantial part (at least 90%) of the fair value of the
asset.
Accounting Models:
1. Sales-type
- Gross investment in the lease = Gross rentals plus gross residual value whether
guaranteed or unguaranteed provided that asset reverts back to the lessor.
- Net investment in the lease = PV of the rentals plus any PV of residual value whether
guaranteed or unguaranteed.
- Unearned interest income = Gross investment less Net investment
- Sales = PV of lease payments or fair value of asset, whichever is lower
- CGS = Cost of the asset plus initial direct cost less any PV of unguaranteed residual
value
- Gross profit or dealer’s profit = Sales less CGS
- Initial direct cost = Expensed immediately, but component of CGS
*Unearned interest income = Total financial revenue
2. Direct Financing Lease
- Gross investment in the lease = Gross rentals plus gross residual value whether
guaranteed or unguaranteed
- Net investment in the lease = Cost of the asset plus initial direct cost
- Unearned interest income = Gross investment less Net investment
- Initial direct cost = Capitalized as cost of the asset, therefore, part of the net investment.
Implicit interest rate in the lease should consider the effect of initial direct cost
1. Transfer of ownership to the lessee at the end of the lease term.
2. Purchase option that is reasonably certain to be exercised.
3. Lease term forms a major part (at least 75%) of the asset’s useful life.
4. Present value(PV) of lease payments is a substantial part (at least 90%) of the fair value of the
asset.
Accounting Models:
1. Sales-type
- Gross investment in the lease = Gross rentals plus gross residual value whether
guaranteed or unguaranteed provided that asset reverts back to the lessor.
- Net investment in the lease = PV of the rentals plus any PV of residual value whether
guaranteed or unguaranteed.
- Unearned interest income = Gross investment less Net investment
- Sales = PV of lease payments or fair value of asset, whichever is lower
- CGS = Cost of the asset plus initial direct cost less any PV of unguaranteed residual
value
- Gross profit or dealer’s profit = Sales less CGS
- Initial direct cost = Expensed immediately, but component of CGS
*Unearned interest income = Total financial revenue
2. Direct Financing Lease
- Gross investment in the lease = Gross rentals plus gross residual value whether
guaranteed or unguaranteed
- Net investment in the lease = Cost of the asset plus initial direct cost
- Unearned interest income = Gross investment less Net investment
- Initial direct cost = Capitalized as cost of the asset, therefore, part of the net investment.
Implicit interest rate in the lease should consider the effect of initial direct cost
