A direct-financing lease is a lessor model used when no sales-type transfer criterion is met. The present value of payments and residual guarantees represents substantially all fair value. Collection also must be probable. The lessor records a net investment and defers selling profit at commencement.
Defer profit and earn a constant return
Build the lease receivable from lease payments and applicable guaranteed residual value. Add the unguaranteed residual asset. Subtract selling profit that Topic 842 requires the lessor to defer. This net investment is then accreted with interest income using a constant periodic rate and reduced for cash receipts. The deferred amount enters income through that yield rather than appearing as a commencement sale.
Suppose payments and residual guarantees have a present value that recovers substantially all of an asset's fair value, collection is probable, and no transfer criterion is met. The lease can be direct financing. If the lessor's carrying amount is below fair value, the difference is not recognized immediately as sales-type profit; it affects the opening net investment and later interest yield.
This route is distinct from operating accounting, where the underlying asset remains in property, plant, and equipment. Read the classification gate in ASC 842-10-25-3 and measurement in ASC 842-30-30-2.
Put the concept to work
Apply this concept
- Prepare and reconcile a supplied direct-financing lease's receivable, residual asset, deferred selling profit and initial direct costs, net investment yield, interest income, receipts, and ending residual.
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Build on these ideas
- Lease receivable and net investment — Apply
To apply this concept: Required. Direct-financing accounting explicitly nets deferred profit within the investment.