CHAPTER 15 SALES TYPE LEASE – LESSOR

The lessor in a Sales type lease is actually a manufacturing or dealer that use the lease as a means
of facilitating the sale of product

A sales type lease involves the recognition of a manufacturer or dealer profit on the transfer of
the asset to the lessee in Addition to the recognition of interest income.

Accounting Considerations

Gross investment – This is equal to the gross rentals for the entire lease term plus the absolute
amount of the residual value, guaranteed or unguaranteed.

Net Investment in the lease – This is equal to the present value of the gross rentals plus the resent
valued of the residual value, Guaranteed/Unguarenteed.

Unearned interest income – This is the difference between the gross investment and net
investment in the Lease.

Sales – The amount equal to the net investment in the lease (Present value of lease payments) or
fair value of the asset, whichever is lower.

Cost of Goods sold – This is equal to the cost of the asset sold minus the present value of
unguaranteed residual value plus initial direct cost paid by the lessor.

Gross Profit – This is the usual formular of sales minus cost of goods sold.

Initial Direct Cost – This amount is expensed immediately in a sales type lease as component of
cost of goods sold.

Illustration

Lessor Company is a dealer in Machinery

On Jan, 1, 2019, machinery was leased to Lessee Company with the following provisions:

Annual rental payable at the end of each year 400,000

Lease Term 5 years

Useful life of Machinery 5 years

Cost of Machinery 1,000,000

Implicit interest rate 12%

Present value of annuity of 1 for 5 years at 12% 3.60

Computation

Gross rentals (4,000,000 x 5) 2,000,000

Present value of rentals (4,000,000 x 3.60) 1,440,000

Unearned Interest income 560,000

Present value of rentals - sales 1,440,000

Cost of Machinery - Cost of goods sold 1,000,000

Gross Profit on sale 440,000

 Sales type lease with residual

At the end of the lease term, the machinery will revert to the Company

Perpetual inventory system is used.

 Residual Value Guaranteed and Unguaranteed residual Value

The lease receivable and unearned interest income are the same whether the scenario is
guaranteed or unguaranteed residual value

There is a difference in the computation of sales and cost of goods sold

Under the “residual value guarantee scenario” the present value of the residual value is included
in the sales revenue because the lessor knows that the entire asset has been sold

Under the unguaranteed residual” the present value of the unguaranteed residual is not included
in the sales revenue.

 Disclosure - Lesser
1. For Finance Lease:
a. Selling profit or loss
b. Finance income on the net investment in the lease
c. Income relating to variable lease payments not included in measurement of net
investment in the lease.
 2. For operating lease, lease income, separately disclosing income relating to variable lease
payments that do not depend on an index rate

Additional Disclosures

A lessor shall disclose additional qualities and quantitative information to assess effect of lease
on Financial Position, Performance and cash flows. Including;

1. Nature of lessors activities

2. How Lessor managers the risks with right associated underlying assets